MOWAT RESEARCH #168 | AUGUST 2018 Inside the Black Blocks A policymaker’s introduction to blockchain, distributed ledger technology and the “Internet of Value” BY MICHAEL CRAWFORD URBAN WITH DANIELLE PINEDA MUNK SCHOOL OF GLOBAL AFFAIRS & PUBLIC POLICY Acknowledgements The authors would like to thank those who participated in this research project as key informant interviewees and anonymous reviewers. A special thanks to Andrew Parkin, Sunil Johal, Kiran Alwani, Catherine Stinson and Reuven Shlozberg for reviewing the paper and for their helpful feedback, as well as Elaine Stam for going above and beyond in her design work for this report. Any remaining errors are the sole responsibility of the authors. Authors MICHAEL CRAWFORD URBAN DANIELLE PINEDA Practice Lead, Government Transformation Policy Intern Michael joined the Mowat Centre as a Policy Associate in January 2016 and took on the role of Practice Lead, Government Transformation in September 2017. He brings a varied set of experiences to his work at Mowat having worked at Global Affairs Canada in Ottawa – most recently as a Cadieux-Léger Fellow – with Elections Canada and in the think-tank and NGO sectors in Toronto and Ottawa. He holds degrees from Queen’s University, Carleton University and the University of Oxford. Danielle worked at the Mowat Centre as a Policy Intern from May to August 2017. She has also worked for Ontario’s Ministry of Health and Long-Term Care, the Legislative Assembly of Ontario and provided teaching and research support at the University of Toronto. She is currently a Policy Analyst at AdvantAge Ontario. Danielle holds a Master of Public Policy and Honours Bachelor of Arts degree in Political Science and Media Studies from the University of Toronto. Disclosure: Michael Crawford Urban owns a small amount of bitcoin and ether. MOWATCENTRE.CA @MOWATCENTRE The Mowat Centre is an independent public policy think tank located at the Munk School of Global Affairs and Public Policy at the University of Toronto. The Mowat Centre is Ontario’s non-partisan, evidence-based voice on public policy. It undertakes collaborative applied policy research, proposes innovative research-driven recommendations, and engages in public dialogue on Canada’s most important national issues. 439 UNIVERSITY AVENUE SUITE 2200, TORONTO, ON M5G 1Y8 CANADA ©2018 ISBN 978-1-77259-068-5 Contents Executive Summary 1 1 2 Introduction 5 A gap in the literature 6 What is a blockchain anyway? 8 Blockchain basics Critical features What problem is blockchain solving? The “double-spend” problem How blockchain works What the fork? Why mine? 8 10 11 13 14 19 21 3 The first digitally native value system 4 Potential uses by the broader public sector 5 Implications for public policy 6 Recommendations Build internal capacity Create an attractive environment for blockchain innovation Support allied and internal experimentation Make greater use of standards and other flexible tools Foster national and global governance cooperation 61 64 67 68 69 7 Conclusion 73 Key takeaways Blinded by the hype? 73 74 Digital commerce New forms of economic activity The dimensions of the blockchain revolution Electronic health records Professional and post-secondary credentials Government permits, licensing and “verifiable claims” Competition in “governance services” Decreasing effectiveness of “negative” regulatory frameworks Novel legal questions Governance 24 24 30 34 42 42 43 44 49 49 54 55 57 61 INSIDE THE BLACK BLOCKS Is blockchain the most important innovation since the Internet, or an over-inflated hype-bubble that will soon burst? EXECUTIVE SUMMARY Is blockchain the most important innovation since the Internet, or an over-inflated hype-bubble that will soon burst? Either way, and even if the truth lies somewhere between these two extremes, rapidly growing interest in blockchain and its potential applications means that policymakers need to quickly develop an understanding of this new technology to guide their engagement with it. Fortunately, there is no shortage of information about blockchain available to policymakers wishing to learn more about it. Unfortunately, too many of the rapidly growing number of articles, YouTube videos, reports and Twitter threads on the subject are of limited use, for one of two reasons. On the one hand, many of these pieces are too superficial, speculative or insufficiently rigorous to be of much use to policymakers. On the other, pieces that do engage at a deeper level often end up losing the forest for the trees by focusing too narrowly on blockchain’s technical aspects. These accounts intimidate and confuse readers without technical backgrounds while the mass of detail they provide obscures many of the most important aspects of this innovation. Compounding this problem is the fact that few of either type of report are targeted specifically at policymakers. This report fills this gap by providing an accessible yet rigorous explanation of how blockchain works and a non-technical but still detailed analysis of the concepts and phenomena that underpin this explanation. It does so with an eye to the significance of blockchain and its potential applications for public policy as well as the potential that exists for governments to use blockchain to advance their own objectives. Throughout, the report also describes potential applications of blockchain and profiles a collaborative blockchain proof of concept conducted by the Government of Canada, the Government of Ontario and the City of Toronto. of a true blockchain: » The ability of multiple collaborators to make additions to the blockchain. » A “write-only” design that ensures information can only be added to the blockchain and never deleted. » Hosting of the blockchain on a decentralized peer-to-peer (P2P) network. 1 | THE MOWAT CENTRE We begin with a discussion of what a blockchain actually is and highlight the six essential components » The use of a distributed consensus mechanism how blockchain, by empowering individuals and by the network for automatically reaching networks, may undermine the usefulness of decisions on whether to accept or reject many of the negative regulatory frameworks – proposed additions to the blockchain. frameworks designed to block certain activities – » An incentive structure integrated into the blockchain’s software that ensures that the nodes maintaining it work together. » The use of cryptography to ensure the security, that governments have previously used to achieve many of their policy objectives. The third issue to watch concerns the fact that blockchain’s spread will likely create a host of novel legal questions – such as how to regulate “smart contracting.” integrity and reliability of the information Finally, we examine the question of how the recorded in the blockchain and of the systems governance of blockchain technology and which manage it. blockchains themselves will need to evolve. We then provide an accessible and non-technical explanation of how a blockchain actually works. Often glossed over in other reports, we explain the process in simple terms because understanding these foundational details is critical to understanding the larger debates about blockchain’s potential and being able to cut through the ubiquitous hype that so often surrounds it. After identifying these issues, the report offers a set of preliminary recommendations for policymakers as they respond to blockchain’s arrival. These include a recommendation to build internal capacity so that governments can stay abreast of blockchain’s evolution and not be entirely reliant on outside consultants. We also discuss how to build an attractive environment for blockchain innovation in Canada. These Building on this explanation, we also identify first two recommendations both depend on, and explore the fundamental implications of and could help government support, internal blockchain’s emergence. To do this, we analyze and allied experimentation with potential the two channels through which blockchain blockchain applications so as to ensure that is likely to have its most important impacts: the public sector can access its potential by enabling greater automation and greater benefits. Insofar as applications of blockchain, decentralization in both the economy and society. such as cryptocurrencies, require regulation we Building on these ideas, we explore a number of recommend that government take a collaborative potential use cases in the broader public sector, approach that makes greater use of standards such as electronic health records, professional and other flexible regulatory tools. Finally, we and post-secondary credentials, as well as strongly recommend that the Government of government permit issuing and licensing. Canada actively lead the fostering of national and 2 | INSIDE THE BLACK BLOCKS global governance cooperation on blockchain. We use this analysis to then identify four critical “Issues to Watch.” The first of these, competition in governance services, focuses on how blockchain enables a much wider range of actors to participate in the market for services, such as the provision of currencies, previously tightly controlled by governments. Second, we discuss Informed by this analysis, the report closes by identifying three key takeaways for policymakers: » Blockchain marks the arrival of the first “digitally native value system.” This in turn lays the foundation for potentially revolutionary forms of automation by enabling software to do many new and important things that it cannot easily do today. » Blockchain and associated technologies offer other less revolutionary, but still significant, innovations in terms of organizing and coordinating information systems and tracking a variety of assets. These implementations will enable greater efficiency and decentralization which could help secure greater privacy and a more even distribution of economic and social power. » The most significant implications of blockchain will arise from its interactions with other emerging technologies such as artificial intelligence and the Internet of Things. Thus, it is critical for government to understand and engage with all of these innovations as part of a wider and interconnected technological revolution which will require a holistic public policy response. Naturally, there are many other issues related to blockchain that will grow in importance in the future but which are not covered here. We hope that, given this report’s analysis of the fundamental concepts and questions raised by this new technology, readers will be better prepared to engage with these issues, ask the what is hype. 3 | THE MOWAT CENTRE right questions and separate what is real from 4 | INSIDE THE BLACK BLOCKS To avoid being caught flat-footed, policymakers will need to understand the basic outlines of blockchain, what it enables us to do that we could not do before and what this means for governments and how they operate. 1 INTRODUCTION On 31 October, 2008, a mysterious individual, or group of individuals, known only as Satoshi Nakamoto, posted a link to a paper entitled Bitcoin: A Peer-to-Peer Electronic Cash System to an obscure mailing list called Cryptography List.2 In this paper, Nakamoto proposed the creation of what would become known as a blockchain as a means of enabling an electronic payment system that did not require a trusted third party intermediary. While Nakamoto has never been publicly1 Still, despite the huge investment in this nascent identified, less than a decade later, Nakamoto’s sector, the incredible growth in the markets for idea has spawned a new class of digital assets digital assets and the massive potential for whose value, as of January 2018, was estimated disruption in a host of industries, blockchain at more than $800 billion (USD). Even with is still absent from many policymakers’ radar a subsequent market correction, the market screens – let alone those of most average capitalization of all existing cryptographic assets citizens. Even for those who have taken notice, is, at the time of this writing, somewhere around few understand the technology much beyond $300 billion. More than that, transformative having a vague impression that it has something applications for the new technology beyond to do with Bitcoin.4 2 3 digital cash are being suggested in areas as diverse as securing digital property, administering This needs to change because, even if blockchain smart electrical grids, enabling self-driving and fails to fulfill its proponents’ wildest claims, self-owning charitable taxis and giving patients or the value of a bitcoin5 drops to nothing, vastly greater control over their own health the opportunities and challenges posed by records. blockchain will offer some of the most significant 1 The paper has been preserved at https://bitcoin.org/bitcoin.pdf. 2 Kharpal , A. 6 February, 2018. “Over $550 billion wiped off cryptocurrencies since record high just under a month ago.” CNBC. https://www.cnbc.com/2018/02/06/bitcoin-price-over-550-billionwiped-off-cryptocurrencies-since-record-high.html. 3 This estimate was made on 25 July, 2018. See https:// ca.investing.com/crypto/currencies for an up to date estimate. These are necessarily very rough estimates. 4 Research conducted on behalf of the Bank of Canada in late 2017 found that 64 per cent of Canadians have heard of Bitcoin but only 2.9 per cent of Canadians actually own any bitcoin. See Henry, C. Huynh, K. and Nicholls, G. December 2017. “Bitcoin Awareness and Usage in Canada.” Staff Working Paper 2017-56 (English). The Bank of Canada. https://www.bankofcanada.ca/2017/12/staffworking-paper-2017-56/. 5 In this paper we follow a common convention when referring to bitcoin. When we use the capitalized Bitcoin, we are referring to the Bitcoin network, blockchain or software protocol. When we use the lower-case bitcoin, we are referring to the currency. 5 | THE MOWAT CENTRE technology-driven tests faced by governments in the next quarter century. Moreover, because of confuse readers without technical backgrounds how they will likely interact with and enable many and the mass of technical detail they provide of the most highly touted technological advances obscures many of the most transformational currently under development, such as artificial aspects of blockchain that are of the greatest intelligence (AI) and the Internet of Things significance for policymakers. Compounding this (IoT), blockchain and related distributed ledger problem is the fact that few of either type of these technology (DLT) will likely represent some of the reports are targeted specifically at policymakers.7 foundational technologies of the 21st century economy. To avoid being caught flat-footed, The critical middle ground that is missing policymakers will need to understand the basic from both these categories is an accessible outlines of blockchain, what it enables us to do yet rigorous explanation of how blockchain that we could not do before and what this means will actually create the changes that are being for governments and how they operate. described and a detailed but non-technical analysis of the concepts and phenomena that A gap in the literature underpin this explanation. This is unfortunate There is no shortage of information about will not be able to develop the understanding of blockchain. In fact, the Internet is overflowing blockchain required to appreciate its potential with explainer articles, videos and reports implications. Without such an understanding, specifically aimed at explaining what blockchain policymakers will not be able to seize the is and how it works.6 Unfortunately, too many opportunities presented by blockchain while also of these pieces fall into one of two categories. avoiding its challenges.8 On the one hand, many are too superficial and insufficiently rigorous to be of much practical use. While they may provide a brief impressionistic sketch of how a blockchain works and perhaps catalogue a few industries that many are predicting will be disrupted by it, they lack the deeper analysis that policymakers will need to grapple successfully with the challenges 6 | INSIDE THE BLACK BLOCKS and opportunities that blockchain will create. because without such accounts policymakers The present report aims to fill this gap by providing the sort of accessible yet rigorous explanation just described. The next section explains blockchain in a straightforward way that will provide the reader with the basic technical understanding needed to engage the larger policy questions discussed later on in the report. The third section builds on this explanation by exploring the fundamental implications of this Alternatively, many accounts that do seek to technical innovation. This third section is aimed engage at a deeper level end up losing the forest squarely at filling the aforementioned gap in the for the trees by narrowly focusing on blockchain’s existing policy research literature by providing technical aspects. These accounts intimidate and 6 Some better examples of these include: MIT Technology Review Editors. April 23, 2018. “What is a blockchain?” MIT Technology Review. https://www.technologyreview.com/s/610833/explainerwhat-is-a-blockchain/. Centre for International Governance Innovation. 4 January, 2018. What is Blockchain? Centre for International Governance Innovation (CIGI). https://www.cigionline. org/multimedia/what-blockchain. 7 A notable recent exception: Berryhill, J., Bourgery, T and Hanson, A. 2018. “Blockchains Unchained: Blockchain Technology and its Use in the Public Sector.” OECD Working Papers on Public Governance. No. 28. http://dx.doi.org/10.1787/3c32c429-en. 8 It is true that there are some useful book length documents of this type that exist. See Vigna, P. and Casey, M. 2016. The Age of Cryptocurrency: How Bitcoin and the Blockchain are Challenging the Global Economic Order. New York: Picador. and Casey, M. and Vigna, P. 2018. The Truth Machine: The Blockchain and the Future of Everything. New York: St Martin’s Press. readers with an examination of blockchain’s This report draws on a research project focused foundational concepts and implications. If you on blockchain technology that was initiated already know what a blockchain is and how it by the Mowat Centre in January 2017. It has works, consider skipping directly to this section. involved interviews with almost 20 public servants, academics, entrepreneurs, practitioners Building on these ideas, the fourth section and thought leaders working in the blockchain explores a number of potential use cases in the sector or in related areas as well as extensive broader public sector, such as electronic health reviews of academic and grey literatures, informal records and professional and post-secondary consultations and jurisdictional scans. credentials. The fifth section then turns to an examination of four “Issues to Watch” which will Finally, as one of our interviewees pointed out, pose critical questions for policy- and decision- one of the reasons that there is such a poor makers. The report closes with a series of five general understanding of blockchain is that it is high-level recommendations for governments as not “the easiest thing to understand.” Blockchain, they consider how to respond to the emergence represents a counter-intuitive and potentially of blockchain and DLT. We also offer some brief radical new way of doing certain things that have concluding thoughts. been done the same way for centuries or, in some cases, a way of doing things that have never been Importantly, this report is not designed to be done before. If anyone is presenting blockchain comprehensive in its discussion of blockchain as simple or easy to understand, it’s likely you will or its applications. At this point, it is much more come away from this interaction missing some important for policy- and decision-makers – as critical pieces of the puzzle. well as the interested public – to develop an understanding of the foundational concepts and In the pages that follow we tackle this complexity issues that it raises. Thus, our aim is to provide head on, break it down and provide the reader policymakers with the basic intellectual tools with the clear exploration of blockchain they will need to continue their exploration of this technology that has been lacking in a public new technology with confidence. Ultimately, our policy context. Ultimately, when someone starts success will be measured by the extent to which talking about “X” amazing thing that blockchain readers come away with confidence in their ability will do, we want the reader to be able to ask to ask the right questions about blockchain as it the questions they will need to ask to be able grows in importance. to cut through the hype and determine whether and how “X” might actually impact the work of 7 | THE MOWAT CENTRE government. 2 WHAT IS A BLOCKCHAIN ANYWAY? Ironically, for something so intimately associated with the technology sector and Silicon Valley-style innovation, the creation of blockchain did not involve the invention of anything new. In fact, all the components of blockchain existed for years prior to its invention. What is innovative about blockchain, however, is its unique combination of these pre-existing elements into a novel configuration that produced something that was much more than the sum of its parts. In this section, we provide a thorough account Blockchains get their name from the process by of what that “something” is and what it can which new transactions are added to this ledger. do. For simplicity’s sake, the focus in this When a user wishes to enter a new transaction section is on the Bitcoin blockchain because, into the ledger, they must first propose, or “post,” as the first blockchain ever created, it set the this transaction to the network. Once it has been basic pattern for subsequent iterations. Once posted, the transaction is grouped together with a basic understanding of what a blockchain a number of other transactions posted at around is has been established, we will expand our the same time. This group of transactions is then focus in subsequent sections to exploring other verified to ensure their validity and, if they are blockchains, how they differ from Bitcoin, and confirmed as valid, they are time-stamped and how they have helped further develop this new “sealed” into a new “block.” Through the use of technology. a technique called “hashing,” this new block is 8 | INSIDE THE BLACK BLOCKS Blockchain basics cryptographically connected to a “chain” of other blocks which were created earlier and which stretch all the way back to the first or “genesis” A blockchain is, fundamentally, a digital ledger block which initiated the blockchain. This process that lists the ownership of a set of assets, as well of connecting new blocks to the chain of older as an essentially tamper-proof transaction history ones ensures that once a block has been added for those assets. Blockchains are operated by a to the chain, earlier blocks cannot be tampered peer-to-peer (P2P) network of computers in which with as doing so would break the connection with each of the computers that form a node on the and invalidate newer blocks (see Figure 1). network independently maintains a complete copy of the ledger. Each copy is regularly updated as the nodes of the network work together to record every transaction that occurs on the blockchain in a way that ensures all copies remain consistent with each other. FIGURE 1 How a blockchain works Someone proposes adding a new transaction to the blockchain. 3 The network gathers a set volume of proposed transactions together. Using the network’s established consensus mechanism, one node veriies and seals these proposed transactions into a new block. 5 Each node independently veriies the validity of the transactions in the new block. If they are deemed acceptable, each node adds this new block to their copy of the blockchain. 2 The proposed transaction is broadcast to a P2P network of computers, called nodes, that operate the blockchain. 4 The new block is then broadcast to the entire network. 6 The proposed update is now a part of the blockchain. 9 Source: PwC. September 2015. Money is no object: Understanding the evolving cryptocurrency market. PwC. https://www.pwc.com/us/en/ industries/financial-services/library/cryptocurrency-evolution.html. 9 | THE MOWAT CENTRE 1 An important feature of the Bitcoin blockchain While DLT is discussed in this report, the core is that it is public and “permissionless,” meaning focus is on blockchain. This is because, while that it can be viewed in its entirety by anyone and DLT has significant potential of its own, it is that anyone can transact on it or set themselves neither as novel, nor potentially as revolutionary, up as one of the nodes that helps to maintain it. an innovation. Given that the focus of this report One important implication of this is that, because is on understanding blockchain and its potential every transaction is recorded on the blockchain, implications, broadening the focus too much risks it is possible to trace the entire transaction further muddying already cloudy waters.12 history of each and every bitcoin ever created. For a variety of reasons that we will explore So, what is so innovative about blockchain? throughout this report, some innovators have Fundamentally, blockchain enables, for the also sought to create “private” or “permissioned” first time, reliable, transparent, searchable blockchains where the abilities to view the and auditable version control of a shared and blockchain, propose transactions and act as a immutable distributed ledger in real time, node maintaining it are restricted in various ways. without the need for a trusted central authority or intermediary to maintain that ledger. While Critical features there is no universally accepted definition Based solely on this overview, it can be difficult to blockchain as combining the following six recognize what is so special about a blockchain. features: Further complicating matters is the fact that there has been a purposeful blurring of the already loose definition of a blockchain by a variety of actors seeking to associate their own offerings with the much-hyped technology as a means of attracting financing and attention.10 Many of of blockchain,13 we find it useful to define a » The ability of multiple collaborators to write to the ledger without a single central point/entity empowered to accept or decline these proposed additions. » A “write-only” design that allows information these technologies are similar to blockchain, or to be added to the ledger but not deleted. While incorporate some of its component technologies, the current state of the ledger can continue to but differ in crucial respects. Indeed, given the be changed, these changes represent updates extent to which the term blockchain is contested, of the existing record, the entirety of which some have abandoned the term altogether and remains accessible on the ledger. refer instead to “distributed ledger technology” or DLT, a broader term that captures blockchains as 10 | INSIDE THE BLACK BLOCKS well as other related technologies.11 10 For an extreme example, see Shapira, A. and Leinz, K. 21 December, 2017. “Long Island Iced Tea Soars After Changing Its Name to Long Blockchain.” Bloomberg. https://www.bloomberg. com/news/articles/2017-12-21/crypto-craze-sees-long-island-icedtea-rename-as-long-blockchain. 11 UK Government Chief Scientific Adviser. December, 2016. Distributed Ledger Technology: beyond block chain. Government of the United Kingdom. https://assets.publishing.service.gov. uk/government/uploads/system/uploads/attachment_data/ file/492972/gs-16-1-distributed-ledger-technology.pdf. 12 This is not to say that DLT is not important as in many cases it will actually be a distributed ledger that gets implemented and not a blockchain, properly defined. Nevertheless, this paper focuses on blockchain as a way of exploring the potential of this new technology with as few qualifications, and with the most clarity, possible – even if actual implementation of the technology, in the form of less revolutionary distributed ledgers, will sometimes fall short of this full potential. 13 We have arrived at this list of features through our own independent research and believe that this represents a robust working definition that side-steps many of the unhelpful technical debates that currently exist and incisively captures the critical features of a true blockchain. » The hosting of the ledger on a distributed P2P network where each full node in this network possesses a regularly updated copy of the entire ledger. » A distributed consensus mechanism by which the network automatically reaches decisions on whether to accept or reject proposed additions to the ledger. » Some form of incentive structure to ensure What problem is blockchain solving? To understand the capabilities enabled by blockchain, and why they add up to something innovative, it helps to understand the problem that blockchain was created to solve. On the surface, this problem may not seem like such a big deal but, as is explained below, the creation that the nodes maintaining the blockchain of blockchain technology actually resolved a provide the computing power needed to do long-standing problem in computer science in a so. For public blockchains like Bitcoin, this revolutionary way. usually takes the form of a “coin” or “token” that nodes can receive as a reward, while private or “permissioned” blockchains employ a greater variety of incentives structures.14 » The use of cryptography to ensure the security, Stated simply, blockchain solves a coordination problem for shared ledgers. Commonly, shared ledgers with multiple collaborators are vulnerable to confusion or tampering leading to errors infiltrating the ledger because it is hard to integrity and immutability of the information coordinate the actions of multiple users when recorded in the ledger and the systems by which they are acting independently. For example, it is managed. one collaborator could accidentally record a transaction that another had already recorded without realizing it. Alternatively, one collaborator might make a transcription error and since no one else was checking their work, the error would go unnoticed, thus corrupting the ledger. In some cases, these are problems people are willing to live with. Google Docs is an example of an application where multiple collaborators can make changes to a single file and where errors or disagreements can creep in. Correspondingly, users will often develop systems for how to alter such files that reduce the likelihood that problems like this will arise, for example, by requiring functions to propose, discuss and agree on changes before they are implemented in the file. Such systems can work well when a group is 14 Some purists would argue that permissioned blockchains are not really blockchains at all precisely because they believe that an incentive structure that employs tokens is an essential component of a blockchain. In this report, we do not take this position. relatively small and known to each other – i.e., a trusting community – but they can also be labour 11 | THE MOWAT CENTRE users to “track changes” and use “commenting” intensive and time-consuming to implement confirm whether the transaction is valid – by and coordinate properly. Moreover, because directly contacting the cardholder for instance. they depend on voluntary human actions and If the transaction is deemed fraudulent, the card are not written into the application’s software, company will use its authority over the ledger such systems are subject to human error and to reverse the transaction and reimburse the can quickly break down when numbers grow and cardholder. when anonymous users and users not known to one another begin to participate. While there are benefits to such a system – refunds for defrauded cardholders for instance In trusting communities, efforts to solve – there are a number of drawbacks that such coordination problems are aimed at keeping intermediated systems create, including: errors out of the ledger. In “trustless” communities – the aforementioned communities Gouging of anonymous users or users not known to The granting of special rights and privileges to a each other – the number of potential problems central authority creates an opportunity for that expands. Users, who must still guard against authority to overcharge users. Many believe that honest errors, must now also guard against credit card companies and banks do just that malicious users who are purposefully seeking and point to the fact that they are able to extract to add incorrect information to the ledger and fees from both the cardholder and the merchant potentially seeking to defraud others. It is in involved in a transaction and are able to make these trustless communities that coordination sizeable profits from this business. It is because difficulties can mutate from a simple nuisance of how these fees eat into their profits that many into a serious security problem and can even small business owners prefer cash or debit block collaboration. payments and why some even decline to accept A common solution to the problems posed by coordination in trustless communities is to create a “trusted” intermediary and give them special powers to oversee the ledger.15 Credit card companies represent an example: you agree to a transaction with a merchant and enter it into a terminal that transmits the proposed transaction to the card company. The company reviews the transaction to see if it appears fraudulent and to 12 | INSIDE THE BLACK BLOCKS determine if the cardholder possesses sufficient credit. If all is well, the transaction is accepted, a new credit is added to the merchant’s account, and a new debit to the cardholder’s account. If fraud is suspected, the card company will utilize the special information it possesses to 15 For the sake of efficiency and convenience, this solution is sometimes attempted in trusting communities as well. credit cards at all. Corruption Systems that centralize authority enable corrupt individuals and organizations to take advantage of the privileges that their authority provides them. Land registries in countries without a strong rule of law often confront this problem as individuals may need to pay bribes to administrators in order to get their transactions processed, and administrators may steal individuals’ title to their land by destroying or secretly altering the records that they maintain. Single points of failure One obvious solution to all these problems is Centralization also generates a more fundamental system where there is no central authority and structural problem, namely the creation of what multiple redundant copies of the information in are called “single points of failure.” These arise question are stored in different places by different when a vital system is operated by, or critical independent entities. If there is no central information is stored by, a single entity or in a authority, it cannot become abusive; if there are single place. The 1 June, 2018 crash of the Visa multiple copies of the ledger, then taking one of network in Europe provides a recent example them offline cannot stop users from accessing of just such a failure.16 Similarly, while users of another copy.19 But, while an obvious and simple Google Docs may be able to log on and edit their solution in principle, prior to the invention of shared files from anywhere in the world, a single blockchain, implementing such a decentralized updated version of the document is maintained solution for a shared ledger was impossible in the by Google. The result of this centralization of context of a trustless world. to decentralize the system, that is, create a storage is that if Google’s servers are taken offline by a cyber-attack or natural disaster, this can shut Google Docs down thereby temporarily blocking everyone’s access to their shared document.17 The “double-spend” problem Honeypots The biggest reason why no one had been able to Centralization, specifically of storage of users’ one had been able to solve the “double-spend” data – something often associated with systems problem.20 To understand the double-spend that centralize authority – also creates what are problem, consider the problem in the context called “honeypots.” The term honeypots refers of a digital currency and imagine a digital unit to large accumulations of data held in a single of money which we will call a “token.” Because location or database. These centralized stores of computers are very good at copying things – and data are especially attractive to hackers because also very good at making millions of these copies of their immense size and potential value. This at low cost – it is not possible to create value- makes it worthwhile for the hackers to devote bearing digital files that act the way a physical significant effort and resources to breaching coin or a dollar bill acts in the physical world. these stores’ defences. Thus, this concentration Counterfeiting is simply too big a problem. One of data often ends up resulting in massive data way to get around this problem, however, is to breaches, even from highly protected databases, a avoid bearers of value altogether and opt instead problem that is becoming increasingly common.18 for a centralized ledger that keeps track of what solve this problem previously was because no 16 Collinson, P. and agency. 2 June, 2018. “Visa card payments system returns to full capacity after crash.” The Guardian. https:// www.theguardian.com/money/2018/jun/01/visa-card-networkcrashes-and-sparks-payment-chaos?CMP=Share_iOSApp_Other. 17 It is true that companies like Google try to alleviate this problem by backing up files, but in principle, because these files are controlled by a single entity, they are still vulnerable to the single point of failure problem – for example, should Google go bankrupt. 18 A recent example is the September 2017 Equifax data breach. 19 Note that decentralized systems also tend to limit the amount of data in the copies of the shared ledgers to the absolute minimum necessary for the system to function. This makes them much less attractive targets for hackers. 20 The double spend problem is most easily understandable in the context of a digital currency, but the same problem can be transposed to other forms of ledgers as well. In order to make the explanation as clear as possible, we concentrate on the currencyrelated form of this problem here. 13 | THE MOWAT CENTRE everyone owns and owes. When someone wants to make a purchase, they don’t exchange tokens. In other words, any decentralized system needs Instead, they simply notify the keeper of the to find a way to ensure that all the various copies ledger to shift some tokens from their account of the ledger remain consistent and are regularly to someone else’s. In this scenario, a token reconciled in a way that reliably ensures that becomes less analogous to a physical thing like a legitimate transactions can be distinguished coin and more like a unit for measuring how much from illegitimate ones and only legitimate ones of something you possess, like a kilogram or a accepted. Prior to the creation of the Bitcoin millilitre. blockchain, no one had been able to solve this problem; blockchain’s key innovation lies in how it As already discussed, this solution works well manages to do so. if there is a trusted intermediary to maintain the ledger and keep track of transactions. For a variety of reasons, the inventor(s) of Bitcoin How blockchain works and its early adopters were unhappy with the Blockchain’s key innovation lies in how it creates fact that such a payment system required them a system for coordinating the maintenance to rely on an intermediary. Thus, the Bitcoin of a shared ledger by a decentralized network blockchain represents an attempt to create a such that all the copies of the ledger across functional equivalent of the sorts of ledgers the network can be reliably updated in a that card companies use to enable electronic timely manner and in a way that ensures their payments, but to do so without a centralized consistency. 21 authority. Instead, a decentralized network would operate the ledger, thereby ensuring that no single How does blockchain accomplish this previously entity would be able to exploit a privileged central impossible task?22 We explained earlier that position. blockchains are updated when a new block of transaction information is time-stamped, The problem that this creates, however, is that sealed and added to the chain of blocks that removing the intermediary re-introduces the comprise the ledger. A block is simply a package double-spend problem, albeit in a different of information of a pre-determined size. In form. Without a central authority empowered principle, this information can record any sort to coordinate the updating of the authoritative of transaction, ranging from the transfer of central ledger, this network needs a new way to ownership of a digital asset like a bitcoin to ensure that malicious users are not able to spend the transfer of ownership of a physical asset the same funds more than once by entering like a diamond that has been registered on a different transactions for their funds into the 14 | INSIDE THE BLACK BLOCKS multiple copies of the ledger distributed around the network. 21 Bitcoin’s creator(s) seem to have wanted to be able to transfer funds digitally with the same level of anonymity and ease that cash enabled in the physical world and they resented the power that the managers of existing ledgers, such as banks, enjoyed because of their privileged position – a position that also enabled them to profit from their management of the ledger. See Vigna, P. and Casey, M. 2016. The Age of Cryptocurrency. Chapter 2. 22 For this section, and many of the other technical aspects of this paper, we have relied on the helpful and accessible explanation offered at Nielsen, M. 6 December, 2013. “How the Bitcoin protocol actually works.” DDI: Data-driven Intelligence. http://www. michaelnielsen.org/ddi/how-the-bitcoin-protocol-actually-works/ as well as the helpful comments of our anonymous reviewers. blockchain.23 The way this works is that when The prize for winning the competition is actually users want to make an addition to the ledger the nonce itself which the winning node is then – i.e., make a transaction – they announce it able to use as a special cryptographic key that to the blockchain’s network. These proposals enables them to seal the next block of validated are validated and grouped together into a block updates and attach it to the rest of the blockchain and the blockchain’s distributed consensus (see Box 1). The various nodes on the network mechanism is then used to add this block to the compete to perform this task because the node ledger. that wins the competition is rewarded with a set number of new bitcoins for doing so. Taking In the case of the Bitcoin blockchain, the part in this competition – i.e., engaging in this consensus mechanism that is used is based on computational work – is called “mining” and the a technique called “proof-of-work” (PoW).24 PoW nodes that do it are called “miners.”26 is essentially a competition held between the various nodes that make up the Bitcoin network in which each node strives to be the first to guess a random number –called the nonce – that happens to solve a difficult mathematical puzzle. There is no way to find the nonce other than by guessing a number and running an equation to see if that number produces the correct answer. This “guess and check” approach, also called brute force computation, is similar to trying to open a combination lock by trying every possible combination one at a time.25 And just like with a combination, it is easy to prove to someone else that you have succeeded in solving the problem by simply telling them the combination and having them test it themselves – which is how other nodes can check to ensure that the winner 23 Volpicelli, G. 8 June, 2016. “Beyond bitcoin. Your life is destined for the blockchain.” Wired. http://www.wired.co.uk/article/futureof-the-blockchain. The big difference between transferring digital and physical assets, however, is that while recording the transfer of bitcoin on the Bitcoin blockchain actually effects and completes the transfer, when recording the transfer of a physical asset that transfer must still be effected in the physical realm. 24 PoW serves two necessary functions in the Bitcoin blockchain: on top of being a consensus mechanism, it also ensures the security of the system, as we explain below. 25 The authors would like to thank Matt Jackson for suggesting this comparison. 26 Note that all of this activity occurs automatically. Human involvement in the mining process is normally limited to setting up a mining “rig” – the computer or network of computers used to do the mining – and periodically checking on it to make sure it is still working properly. That said, the potential deviations described below would involve human interference with a normally automated process. 15 | THE MOWAT CENTRE of the competition actually found the nonce. BOX 1 Hashing Hashing is a term that refers to the use of an algorithm – called a hash function – to convert a piece of information into an alphanumeric string of characters like this: e9ffc424b79f4f6ab42d11c81156d3a17228d6b1edf4139be78e948a9332d7d8 Hashing is a commonly used technique in computer science and cryptography. Hashes are useful because they possess a few important properties. First, hashes are extremely sensitive to any change in the information from which they were generated. For instance, if the hash above was the result of the text of a book being hashed, the simple act of removing even a single period from that text and then hashing the text again would result in the generation of an entirely new and unpredictably different string of characters. Second, some hash functions – such as SHA-256, the hash function used by Bitcoin but also many other common digital applications – are very useful for cryptographic purposes. While it is easy to apply the function to a piece of information and generate a hash, it is essentially impossible to do the inverse and figure out what the underlying information is simply by inspecting the hash itself. Thus, if you have access to the underlying information used to generate a hash, it is easy to determine if the person who generated it does as well, while if you only have the hash itself, you will be unable to determine what that underlying information actually is. 16 | INSIDE THE BLACK BLOCKS In the Bitcoin blockchain, hashing plays a critical role. The number guessing competition that constitutes mining is actually a competition to guess a number (called the nonce) that, when added to the transactions in the proposed block and hashed using the SHA-256 hash function, will generate a hash starting with a specific number of zeros. The specific number of zeros required is automatically set by the Bitcoin software and varies depending on the “hashrate” of the Bitcoin network. The “hashrate” of the network is a measure of how much computing power is being devoted to maintaining the network at that particular point in time. The Bitcoin software automatically varies the difficulty of the competition depending on the network’s hashrate so as to maintain an average interval between block creation of about 10 minutes.27 Once the nonce has been guessed correctly, it is then hashed again alongside the transaction information for the block being sealed and the hash of the preceding block (see Figure 2). It is in this way, namely hashing all the information in a block and then using this hash as a part of the information that produces the next block, that Bitcoin makes itself essentially tamper-proof. Any attempt to go back in time by tampering the record of historical transactions will alter the underlying information of the hash of the block in which this transaction was recorded, thereby invalidating the hashes of subsequent blocks and breaking the chain.28 27 In reality, the average time per block has been slightly below 10 minutes for most of Bitcoin’s history. See https://data.bitcoinity.org/ bitcoin/block_time/all?f=m10&t=l. 28 For a more detailed explanation of hashing see 3Blue1Brown. 7 July, 2017. “Ever wonder how Bitcoin (and other cryptocurrencies) actually work?” YouTube. https://www.youtube.com/watch?v=bBC-nXj3Ng4 and Nielsen, M. 6 December, 2013. “How the Bitcoin protocol actually works.” FIGURE 2 Blockchain detail K OC BL S IOU EV PR F O Alice pays John SH HA 6 Bitcoins Mark pays Sara 8 Bitcoins Mike pays Alfred 5 Bitcoins CE ON EN H T HA SH FU NC TIO N 17 | THE MOWAT CENTRE HA SH FU NC TIO N This mathematical puzzle is important because it allow a user to transfer the same asset to more serves three key functions: than one other user simultaneously (an obvious » It makes participation in the competition costly form of double-spending). Nor would it validate by requiring participating nodes to dedicate proposed transactions that are inconsistent with significant computing power to maintaining the the pre-existing state of the database – e.g., a network. user attempting to transfer an asset that they do » It yields an answer that is easy to confirm after the fact but essentially impossible to uncover Once they have sealed the block, the winning without winning the competition. miner broadcasts this new block to the rest of » Because the nonce can only be found by the network and each of the other miners update guessing random numbers, it is basically their copies of the blockchain by adding this new impossible to predict who will win any given block. Before doing so, however, each miner will round of the competition, thereby randomizing independently verify that the solution that the which miner gets to seal each block. competition winner found to the mathematical While dedicating additional computing power to finding the nonce will improve a miner’s chances of winning, doing so does not guarantee victory – especially because all the other competitors are trying to do so as well. In other words, the competition is like a lottery and while adding computational power will improve a miner’s odds of winning because it will allow them to guess and check more numbers more quickly – similar to buying additional tickets – the winner of the competition will still be determined by random chance. Once a miner finds the nonce and seals the block, the next step is to broadcast this new block to the rest of the network. It should be noted that prior to sealing the block, prior even to searching for the nonce, the miner will have automatically validated all the pending transactions that it 18 | INSIDE THE BLACK BLOCKS not own. had gathered to put into this new block. The process of validation is fairly straightforward and consists of the copy of the Bitcoin software that operates the miner’s node checking to see if there are any inconsistencies within the proposed transactions that make up the proposed block. For example, the Bitcoin software does not puzzle is correct and that the additions to the blockchain proposed in the new block are compatible with their copies of the blockchain. This step is important because technically the winner of the competition could try to introduce improper transactions that benefited them into the blockchain when they seal the block and broadcast it to the rest of the network. But any such attempt would immediately be noticed by the other nodes when they received the proposed new block with the result that this new block would be promptly rejected by the network and the process would be re-run. Because it is so easily caught, attempts like this are not a regular occurrence. What the fork? One of the interesting things about Bitcoin is FIGURE 3 Normal blockchain growth that, while a new block is created every ten minutes, most users of Bitcoin do not consider Miners a transaction to have been completed until an additional five blocks have been added to the New block blockchain. In order to understand why this is the case, we need to explain one additional feature of blockchains, namely something called “forking.” Because blockchains are maintained by a decentralized worldwide network of computers, it is possible for more than one node on the network to independently solve the mathematical FIGURE 4 Forked blockchain puzzle and win the competition to seal the next BRANCH A block at basically the same time. When this Miners occurs, more than one node will broadcast a new block to the network essentially simultaneously. While communication between nodes takes place very quickly, it is not instantaneous Miners because geographical location, routing of the BRANCH B information on the Internet, and the quality of the transmission infrastructure will impact transmission speed. Thus, the spreading of new Normally, however, this competition between blocks across the network will proceed unevenly branches does not last long because the Bitcoin and at different rates. This uneven spreading can software contains another rule designed to result in a situation where multiple nodes on the resolve it: the longest branch of the blockchain network may accept one new block while other is considered the official branch and miners nodes, having received an alternate new block should only work on extending the official branch. from a different node first, will have accepted a Thus, as soon as one of the competing branches different block and added it to their blockchains. successfully adds another block to the chain, this the blockchain – the name given to situations when the blockchain has been split into multiple branches as just described – by using the following rule: all nodes simultaneously keep track of both branches of the chain but only work on extending the branch containing the new block that they accepted first. The result is that there are temporarily two competing versions of the blockchain (see Figure 4). now longer branch becomes the official branch. Once nodes that were working on the other, now shorter, branch are informed that there is now a longer branch, they will automatically stop working on extending the shorter branch and transfer their attention to the now official branch (see Figure 5). The blocks in the shorter chains that have been abandoned are called “orphan blocks.” 19 | THE MOWAT CENTRE The Bitcoin software manages this “forking” of Branch A Miners move would go back in time on the blockchain and FIGURE 5 propose a new block that contained a new Forked blockchain being resolved transaction history for the bitcoins in question Branch A Miners move to Branch B in which they never transferred these bitcoins to their counterparty. The idea being that if they can BRANCH A Miners get the rest of the network to accept this new transaction history they can recover the funds they spent while still enjoying the benefits of the transaction. BRANCH B While not unusual or problematic, forking does enable the double-spend problem to re-emerge FIGURE 6 Attempt to fork a blockchain retroactively in a new form. In this context, double-spending refers to a scenario in which a fraudster completes a transaction with another user and BRANCH A The Fraudster Miners then, at some point later in time after they have secured the benefit of this first transaction – say BRANCH B taken possession of the pizza they purchased through that transaction – seek to remove the record of this transaction from the blockchain. The only way that such a manoeuvre would be In other words, by erasing the record of their successful is if the fraudster were somehow able transaction, they are seeking to destroy the to convince the rest of the network that their new evidence that it occurred and return the official and fraudulent branch of the blockchain should blockchain to the state that existed before be accepted as the official branch. Otherwise the they transferred the bitcoins used to make the fraudster would simply be operating their own purchase out of their account, thereby allowing private branch of the blockchain with no one else them to spend these same bitcoins again in the paying any attention to them or engaging in any future. The result would, in some ways, be similar transactions with them. Essentially, it would be to passing a bad cheque. a bit like trying to spend your own homemade The way that a fraudster would try to do this is by waiting until they have secured the benefit of the transaction and then return to a point 20 | INSIDE THE BLACK BLOCKS on the blockchain, usually the block just prior to the one in which the transaction in question was recorded, and then fork the blockchain by proposing a new block in which that transaction no longer exists.29 In other words, the fraudster 29 Note, in this scenario all the other transactions in the block would remain the same – only the transaction of interest to the fraudster would be altered. currency at the grocery store. To be successful, the fraudster would need to transaction has been completed: the assumption extend their new fraudulent branch of the chain is that once that many blocks have been added, such that it overtakes the legitimate chain – the it is so improbable that the transaction could one that includes the original transaction – in be overtaken by a fraudulent branch of the length. While theoretically possible, the Bitcoin blockchain that they can now rest assured that it blockchain is specifically designed to make such has been permanently added to the blockchain. a scenario essentially impossible. The main defence that is built into the Bitcoin blockchain is PoW. While it is possible for anyone to fork the Bitcoin blockchain at any time, once they have FIGURE 7 Blockchain with forks and orphan blocks created the first block in the new branch, they will have to seal each subsequent block in this new chain themselves. This is because, until ORPHAN BLOCK ORPHAN BLOCK OFFICIAL BRANCH they overtake the official branch the rest of the network will still be focused on extending the longer official chain. ORPHAN BLOCK Given that the difficulty of finding the nonce will be the same for the fraudulent actor and the rest of the network against which they are still competing, it is tremendously unlikely that Why mine? the fraudster will be able to seal enough blocks A final key point to note about blockchain design fast enough to overtake the original branch and is the role played by the distributed P2P character displace it as the official branch. While they of the network. The consensus mechanism relies could reasonably expect to get lucky and seal a on the fact that each node has access to its own block or two faster than the rest of the network, copy of the blockchain to ensure that whoever being able to do so for an extended period of wins the competition is able to independently time becomes so unlikely as to be essentially validate the new block of transactions. This impossible. That is why users of the network makes it is essentially impossible to corrupt usually wait until five additional blocks have been the ledger by hacking it. In the first instance added to the chain before assuming that their this is because, given that each block in the 30 chain contains a hash of the preceding one, it is essentially impossible to alter the record as doing so would break the modified block’s connection with subsequent blocks and create a fork in the chain (see Box 1). Additionally, the fact that each node has its own copy of the ledger means that it would be simply too difficult to simultaneously hack enough nodes for the hacker to be able to alter sufficient copies of the ledger to overwhelm the non-corrupted versions of the blockchain. 21 | THE MOWAT CENTRE 30 The integrity of this system would be threatened, however, if a single entity came to control a sufficiently large percentage of the computing power dedicated to the network that they could, essentially, guarantee their ability to win the lottery. This hypothetical problem is referred to as a “51 per cent attack,” though there are some who argue that one could probably mount such an attack with less than 51 per cent of the network’s computing power. At the moment, the Bitcoin blockchain does not appear to be vulnerable in this way. For a more in-depth discussion, see Hertig, A. 8 June, 2018. “Blockchain’s Once-Feared 51% Attack Is Now Becoming Regular.” Coindesk. https://www.coindesk.com/ blockchains-feared-51-attack-now-becoming-regular/. and Eyal, I and Gün Sirer, E. No date. Majority is not Enough: Bitcoin Mining is Vulnerable. Cornell University. https://www.cs.cornell.edu/~ie53/ publications/btcProcFC.pdf. The major drawback to this otherwise ingenious for these updates in many blocks. Thus, users scheme for preventing corruption of the ledger will now often offer modest fees alongside their is that the entire system relies heavily on proposed transactions in order to induce miners redundancy and is thus quite inefficient. The to include their proposed transaction in a block difficulty of winning the competition to seal the in a timely manner. Thus, between mining new next block is automatically tied to the amount bitcoins and receiving transaction fees, Bitcoin of computing power that nodes have dedicated miners are provided with an incentive to maintain to maintaining the network. While it was initially the decentralized system. possible to successfully mine bitcoins using only a standard laptop computer, the amount of computing power competing to seal the next block, and the costs involved in purchasing the electricity to enter this competition, are now so high that attempting to mine bitcoins using anything other than specially designed hardware is a money losing proposition.31 But, if participating in this competition is expensive, why does anyone compete? The answer is twofold. First, blockchains usually include a system that incentivizes participation by providing the winner of the competition with a reward, usually in the form of a token. In the Bitcoin blockchain, this reward is a set number of bitcoins.32 Second, when users notify the network of their proposed update and request that it be included in the next block, they can also offer a fee for processing their update. During the first few years of its operation, these fees were minimal or non-existent on the Bitcoin blockchain. But as the volume of updates has grown there are 22 | INSIDE THE BLACK BLOCKS now often more proposed updates than space 31 Eventually this energy intensity may force the adoption of alternative consensus mechanisms by Bitcoin and other blockchains. Ou, E. 7 December, 2017. “No, Bitcoin Won’t Boil the Oceans.” Bloomberg. https://www.bloomberg.com/view/ articles/2017-12-07/bitcoin-is-greener-than-its-critics-think. 32 Initially, the reward for successfully sealing a block was 50 bitcoins. Interestingly, the Bitcoin software is set such that the reward decreases by half about every four years. Currently, the reward sits at 12.5 bitcoins (worth, at the time of this writing, over $130,000 CAD). Eventually, the reward will decrease to nothing with the 21 millionth, and final, new bitcoin likely appearing sometime around 2140, depending on what the average time required per block actually ends up being. 23 | THE MOWAT CENTRE At some point you need someone to staple this physical thing and this digital thing together... and the stapler can always corrupt the system. 3 THE FIRST DIGITALLY NATIVE VALUE SYSTEM With this understanding of how blockchain functions in place, we can shift our focus to the potential implications of this new technology. As was mentioned earlier, applications for blockchain technology are being proposed, developed and launched across an increasingly diverse array of sectors ranging from personal digital identity management, to electricity grids,33 to digital pet breeding games.34 In subsequent sections we highlight a few of these applications. Before diving too deeply into specific applications, however, it is important to first get to grips with the fundamental innovations introduced by blockchain which underpin these new applications. Thus, in this section, we focus on the two key dimensions along which blockchain’s impact will likely flow, namely automation and decentralization. Digital commerce Before examining these two key dimensions, however, it is useful to quickly review the context into which blockchain is emerging and illuminate the significant changes to this context it may trigger. Enthusiasts often suggest that blockchain is important because it creates an “Internet of Value” in the same way that the worldwide web created an “Internet of Information.”35 Similarly, others suggest that blockchain is the “distributed trust network that the Internet has always needed but never had.”36 Care should be taken with these catchy turns-of-phrase, however, as it is often unclear what they actually mean or what the implications of an “Internet of Value” might be. After all, we can already transfer value 24 | INSIDE THE BLACK BLOCKS across the Internet fairly easily – as shown in Figure 8, digital commerce is already booming. 33 Briggs, L. 2 December, 2016. “NEWS: Energy May be Ripe for the Sharing Economy, Thanks to Bitcoin’s Blockchain Technology.” Advanced Energy Perspectives. http://blog.aee.net/news-energy-may-be-ripe-for-the-sharing-economy-thanks-to-bitcoins-blockchain-technology. 34 See https://www.cryptokitties.co/. 35 Hasse, F. von Perfall, A. Hillebrand, T. Smole, E. Lay, L. Charlet, M. 2016. Blockchain – an opportunity for energy producers and consumers? PwC. https://www.pwc.com/gx/en/industries/energy-utilities-resources/publications/opportunity-for-energy-producers.html. Page 40. 36 Marc Andreessen, quoted in Tapscott, D. and Tapscott, A. 2016. Blockchain Revolution: How the Technology Behind Bitcoin is Changing Money, Business and the World. London: Portfolio Penguin. Page 5. This is a confusing quotation as the great innovation of blockchain is not that it creates a network of trust, but rather, that it eliminates the need for trust. FIGURE 8 BOX 2 Fiat Currency Growth of digital commerce 4.5 Trillions (USD) 1.3 2014 3.9 3.3 2.8 1.5 2015 1.9 2016 2.3 2017 2018 2019 2020 2021 PROJECTED SALES Source: Orendorf, A. 1 September, 2017. Global Ecommerce: Statistics and International Growth Trends [Infographic]. ShopifyPlus. https://www.shopify.com/enterprise/globalecommerce-statistics and Statisa. 2018. “Retail e-commerce sales worldwide from 2014 to 2021 (in billion U.S. dollars).” E-Commerce. Statisa. https://www.statista.com/ statistics/379046/worldwide-retail-e-commerce-sales/. What is special about blockchain is how it has enabled, for the first time, the creation of what we call the first “digitally native value system.” More than anything else, it is this innovation that stands to enable blockchain’s most revolutionary consequences. The key difference between existing forms of value that can be transferred digitally and blockchain-enabled forms of digital value is that unlike existing forms – such as “fiat” currencies (see Box 2) like dollars, euros, yen – which are only represented digitally, blockchain allows the creation of forms of value that are intrinsically digital. Most existing systems of value are created and controlled through legislation. These currencies derive their value from a system of laws that exists independent of the digital realm. This means that any digital representation of these forms of value is only the representation of an original version which is ultimately controlled and defined by that other system. The term “fiat currency” refers to the money, such as Canadian dollars, that we currently use and which have value only because some entity, such as a government or central bank, has declared them to have this value. This value is usually substantiated by an individual’s ability to pay the taxes owed by them to said government in currency backed by this government. Fiat money has no independent intrinsic value, as opposed to representative currency (where money represents a claim on a commodity, usually held by a government) or commodity money (where the money has intrinsic value by dint of the usefulness of the commodity, often a precious metal, out of which it is made). Alternatively, blockchain-enabled assets are originally digital function of the digital system they are embedded in, impossible outside of this context and independent of any national system of laws.37 37 For an in-depth discussion of the legal character of Bitcoin and the difficulties involved in understanding it using traditional legal concepts, see Szilagyi, K. 2018. “A Bundle of Blockchains? Digitally Disrupting Property Law.” Cumberland Law Review. 48(1) 9-34. 25 | THE MOWAT CENTRE and are controlled and defined by software. Their existence is a This is new and profoundly important. Digitally native value systems represent a potentially tremendous disruption to the institutions that currently manage the connection between existing digital representations of existing forms of value and their physical and legal anchors. These intermediary institutions, which derive considerable power from their roles as such, are currently necessary because, as one of our key informants put it, “at some point you need someone to staple this physical thing and this digital thing together... [and] [t]he stapler can always corrupt the system.”38 When a form of value is inherently digital, however, this is no longer true because the stapler is no longer necessary. Consequently, those currently holding the stapler stand to lose a great deal of their power. While much has been made of the disruptive potential that blockchains possess vis-à-vis traditional financial institutions, this potential disruption is just one of many possible repercussions of the even more fundamental shift that the advent of digitally native value systems entails. Indeed, the most significant result that is likely to emerge from blockchain’s creation of digitally native value systems lies in how the novel characteristics of these systems will enable new areas of economic activity that were not 26 | INSIDE THE BLACK BLOCKS previously possible. 38 Corruption is perhaps a strong word, but the point is clear. Banks and governments exercise tremendous power over the existing financial system, but this power is often hidden. Only rarely, for instance when the Greek government and the country’s banks effectively froze Greeks’ bank accounts in 2015 and limited them to a maximum of only €60 worth of withdrawals a day, does this power become obvious. The Associated Press. 29 June, 2015. “Greece in limbo as it shuts banks, puts limits on cash withdrawals to avoid financial collapse.” The National Post. http://business. financialpost.com/news/economy/greece-in-shock-as-banks-shutafter-creditor-talks-break-down. BOX 3 Digital Assets According to Investing.com there are now more than 1,900 “cryptocurrencies.”39 While many of these, such as Bitcoin, are best understood as something akin to a traditional currency, for many of these assets the term “cryptocurrency” is actually misleading as it implies a level of homogeneity among these assets that does not exist. Increasingly, the terms “crypto assets” or “digital assets” are being used as a way of referring to this universe of distinct digital tokens.40 In an attempt to organize this expanding universe, Don and Alex Tapscott have developed an initial typology that divides this new class of assets into seven categories.41 Drawing on their work, we define each of these categories below and provide examples of particular tokens for each category. It is important to note, however, that this list is offered as a helpful guide and is by no means definitive or exhaustive. The divisions between these categories are blurry as many are still emerging and evolving, and any attempt at such categorization will need to be amended in the months and years to come. CRYPTOCURRENCY A blockchain-based system of digital cash money that serves as a P2P medium of exchange, store of value and unit of account and which uses cryptographic techniques to generate new units of money and to secure the system against corruption. Cryptocurrency has no physical form and exists only on the network. Units of different cryptocurrencies can be exchanged for each other or exchanged for fiat currency. This money-changing usually occurs at cryptocurrency “exchanges,” institutions that act like digital foreign currency exchanges. Bitcoin is the most well-known cryptocurrency, but other cryptocurrencies that focus on providing specific functionalities such as Zcash (improved privacy) or Litecoin (faster transaction confirmations) also exist. Similarly to cryptocurrencies, platform tokens are units of value within digitally native value systems. Unlike cryptocurrencies, which are specifically designed to enable secure digital payment systems, platform tokens are designed to serve as value systems for general purpose blockchainbased software platforms capable of supporting additional functions beyond payments. Ether, the token that is native to the Ethereum platform, is the most well-known of these tokens. Ethereum, a blockchain that emerged out of its creators’ frustration with the Bitcoin blockchain’s limited ability to support applications other than digital payments, was designed to provide users with the ability to run “smart contracts” (business logic and agreements encoded in software - see Box 4) – and DApps (decentralized applications, i.e., software programs like Bitcoin that run on a decentralized P2P network) on its network. The role of the ether token, which represents an entitlement to the use of some of the Ethereum network’s decentralized computing power – often called “gas” – is a component of an internal pricing system used to allocate the computing power of the network. 39 See https://ca.investing.com/crypto/currencies This estimate was made on 26 July, 2018. 40 Garner, B. 14 February, 2018. “What is Storj? | Beginner’s Guide.” CoinCentral. https://coincentral.com/storj-beginners-guide/. 41 Tapscott, A. 28 March, 2018. “Crypto Summit 2018 | Alex Tapscott: Global State of Crypto.” YouTube. https://www.youtube.com/ watch?time_continue=1602&v=YM4EwxQ3eFY. 27 | THE MOWAT CENTRE PLATFORM TOKENS UTILITY TOKENS Like cryptocurrencies and platform tokens, utility tokens are also units within digitally native value systems. Contrary to platform tokens, which are native to general purpose decentralized computing systems, utility tokens serve as units of value within the digital value systems created by specific DApps. Thus, while a DApp might require a platform token such as ether to pay nodes on the Ethereum network for the computational work they perform to run the DApp, users of the DApp would need to spend or hold that DApp’s native utility token to participate in the activities of that DApp. Storj, a decentralized cloud storage DApp that runs on the Ethereum network, is one such example. Storj users who want to store data (called tenants) upload data to the cloud through the Storj DApp. Storj processes this data and deposits it with users who have spare storage capacity (called farmers). Tenants whose data is being stored pay the farmers who are storing their data using Storj’s native utility token.฀ SECURITY TOKENS Security tokens are best understood as securities – such as stocks or other equities – issued digitally on a blockchain platform. In other words, security tokens are tokens that constitute an “investment contract” and thus meet the legal criteria used to define a security. These criteria are often referred to in the USA as the “Howey Test” or, in Canada, by the name of the court case (Pacific Coast Coin Exchange v. Ontario Securities Commission) that imported a slightly wider version of the Howey Test into Canadian law. Essentially, according to this test, a token is a security if it involves: » an investment of money » in a common enterprise » with the expectation of profit » to come significantly from the efforts of others42 There are many potential advantages to issuing securities on a blockchain, such as faster clearing and settling of transactions, better tracking of ownership, and other features enabled by the fact that these tokens, unlike paper share certificates, are programmable, meaning they can be controlled by software.43฀ 28 | INSIDE THE BLACK BLOCKS NATURAL ASSET TOKENS While similar to security tokens in that they represent an entitlement to the ownership of an asset, natural asset tokens represent ownership of a physical asset, such as a specific amount of gold or oil, instead of an intangible asset like a share in a company. Alex Tapscott suggests that these tokens might be most useful in creating or advancing what he calls “frontier markets” in physical assets like atmospheric carbon emissions. Indeed, some interviewees told us that some governments are already examining the possibility of using blockchains to implement carbon pricing systems. 42 Canadian Securities Administrators. 24 August, 2017. “Cryptocurrency Offerings.” CSA Staff Notice 46-307. http://www.osc.gov.on.ca/en/ SecuritiesLaw_csa_20170824_cryptocurrency-offerings.htm. 43 Currently, however, many existing securities tokens have likely been issued without meeting many of the requirements, such as the issuing of a regulator-approved prospectus, that have been set by securities regulators. Consequently, many of these token are likely illegal offerings. DIGITAL COLLECTIBLES In much the same way that the creation of blockchain technology solved the double-spend problem for digital currency, its creation of “digital scarcity” is now enabling the production of unique nonreplicable digital collectibles. The most well-known of these are CryptoKitties which exist as tokens in a blockchain-based game in which players are able to collect and breed unique digital “cats.” Other collectibles have started to emerge, such as the ability to buy a share of a musician’s song44 or digital trading cards. Indeed, impressed by the success of CryptoKitties, Major League Baseball announced that it will soon launch a blockchain-based game involving crypto-collectible avatars from significant moments in baseball history which users will be able to collect and trade with each other.45 The market for digital collectibles may be larger than one would initially imagine: in computer gaming circles, the sale of fraudulent digital items such as in-game weaponry – which for our purposes count as collectibles – is a major problem in a growing market already worth 15 billion USD.46 CRYPTO-FIAT CURRENCIES OR STABLECOINS 44 Krewen, N. 10 December, 2017. “Want to buy a piece of a Drake song? Track’s rights sold via pioneering digital currency scheme.” The Toronto Star. https://www.thestar.com/entertainment/music/2017/12/10/want-to-buy-a-piece-of-a-drake-song-tracks-rights-sold-viapioneering-digital-currency-scheme.html. 45 Kelly, M. 13 July, 2018. “MLB will release a crypto baseball game on the blockchain.” The Verge. https://www.theverge. com/2018/7/13/17568766/mlb-cryptocurrency-baseball-game-summer. 46 Casey, M and Vigna, P. 2018. The Truth Machine. Page 96. An important innovation that sets blockchain-based collectibles apart from other digital ones is that they exist on a decentralized network and are thus less vulnerable to the single point of failure problem that exists for other digital items, such as collectibles in online games run by a single company like World of Warcraft. Wong, J. 4 December, 2017. “The ethereum network is getting jammed up because people are rushing to buy cartoon cats on its blockchain.” Quartz. https:// qz.com/1145833/cryptokitties-is-causing-ethereum-network-congestion/. 47 Venezuela’s petro, a digital currency that it began issuing in February 2018 and which it claims is backed by Venezuela’s oil reserves, appears to represent some combination of these two ideas, but it may also be a scam designed to circumvent international financial sanctions. Laya, P. “Crypto Rating Sites Are Already Calling Venezuela’s Petro a Scam.” Bloomberg. https://www.bloomberg.com/news/. articles/2018-04-03/crypto-rating-sites-are-already-calling-venezuela-s-petro-a-scam and Karsten, J. and West, D. 9 March, 2018. “Venezuela’s “petro” undermines other cryptocurrencies – and international sanctions.” TechTank. The Brookings Institute. https://www. brookings.edu/blog/techtank/2018/03/09/venezuelas-petro-undermines-other-cryptocurrencies-and-international-sanctions/. 29 | THE MOWAT CENTRE Given how the current volatility of cryptocurrencies has undermined their usefulness as a medium of exchange, some have suggested that governments could issue a digital fiat currency on a blockchain as a means of overcoming this problem. The idea would be that such a currency would marry many of the advantages of a fiat currency, such as the stability that can derive from government backing, with many of the advantages of a cryptocurrency, such as faster transaction speeds and the ability to easily transfer money across borders. Stablecoins, such as Tether, seek to achieve much the same result by creating a system whereby the value of a token is pegged to a specific physical asset like gold or oil or even to an existing fiat currency.47 New forms of economic activity Some commentators compare the invention FIGURE 9 Space of possible economic relationships, circa 2007 of blockchain to the invention of double-entry bookkeeping. Often, this comparison is designed Mortgage to highlight the foundational importance of blockchain but also to caution readers not to Credit card balance expect too much from blockchain too soon. After Loan from parents all, while double-entry bookkeeping may have enabled the development of modern capitalism, Stock ownership it took hundreds of years before the practice Interest-bearing bank deposit became a ubiquitous backbone technology of commerce.48 The space illustrated in Figure 9 represents all economic relationships between individuals Another analogy that may be better at illustrating that could theoretically exist. The portion of the how blockchain can enable novel forms of space in the bottom right-hand corner – coloured economic activity is to consider how other light green and encompassing the five icons new developments, such as the invention of – represents all the economic relationships joint stock companies, did so when they were that were actually available at the level of launched. The creation of these technologies technology that existed prior to the invention of enabled a new class of enterprises to raise capital blockchain technology. The five icons represent in innovative ways and to create business models illustrative examples of the many potential and businesses that were not previously viable. relationships available within that portion of These new economic entities also opened up the space. Because of how technology changes previously restricted commercial opportunities over time, the size of this space of possible to a wider percentage of the population than economic relations also changes as the level ever before and helped to spur significant wealth of technological development changes. For creation and economic growth. example, Figure 10 represents the space of Josh Stark, a lawyer and blockchain entrepreneur, illustrates this idea by using a concept that he calls the “space of possible economic relationships.”49 We have adapted his graphical 30 | INSIDE THE BLACK BLOCKS representation of this concept in Figures 9 -12. 48 The Economist. 15 July, 2017. “Disrupting the trust business.” The Economist. https://www.economist.com/news/worldif/21724906-trust-business-little-noticed-huge-startups-deployingblockchain-technology-threaten. 49 Stark, J. 26 July, 2018. The Space of Possible Economic Relationships. Medium. https://medium.com/@jjmstark/the-spaceof-possible-economic-relationships-bca4511fa88b. possible economic relationships as well as the actual relationships available to the ancient Romans. Notice how it is smaller and more limited in examples than Figure 9. FIGURE 10 FIGURE 12 Space of possible economic relationships in ancient Rome, circa 200 Space of possible economic relationships, circa 2018 Mortgage Cryptocurrencies Loan from parents Interest-bearing bank deposit Initial coin offerings Credit card balance Stock ownership Loan from parents Interest-bearing bank deposit Over time, technology developed and new ICOs provide good examples of how the sort of innovations arrived making more of this space expansion described in these figures is occurring available. In Figure 11, we illustrate how the as well as its potential impacts, both good and space had evolved and expanded by the mid- bad. ICO proponents argue that they offer an 1800s. easier way for investors to raise funds than through existing sources like angel investors and venture capitalists. They also argue that ICOs are FIGURE 11 more democratic and fair because of how they Space of possible economic relationships in Victorian England, circa 1850 provide retail investors anywhere in the world with the opportunity to invest in exciting new technologies at the ground level, an opportunity previously reserved for well-connected and already wealthy accredited investors. Mortgage Loan from parents Stock ownership Interest-bearing bank deposit As is shown in Figure 12, the advent of of the space of possible economic relationships that is available as new inventions such as cryptocurrencies and initial coin offerings (ICOs) emerge. 31 | THE MOWAT CENTRE blockchain is further increasing the proportion BOX 4 32 | INSIDE THE BLACK BLOCKS Initial Coin Offerings (ICOs) An ICO is an unregulated sale of digital coins or tokens generally used by blockchain start-ups and entrepreneurs to raise funds for their ventures. Sometimes these coins have characteristics, such as voting rights or the right to use a service offered on that blockchain, associated with them. The purchase of the tokens sold in an ICO is usually made using one of the most popular cryptocurrencies such as bitcoin or ether. The term ICO is modelled after the term IPO, or Initial Public Offering, which refers to the raising of investment capital by a private corporation through the regulated sale of stock to the public for the first time. ICOs are controversial because of their unregulated nature and are banned in some countries such as China. In other countries, regulators have warned consumers that many of the tokens sold in ICOs may constitute illegal securities. Other jurisdictions, such as Singapore, Hong Kong and Switzerland are more accepting and accommodating of ICOs. ICOs have proven both popular and lucrative as it is estimated that in 2017, entrepreneurs raised more funds through ICOs than from traditional early-stage venture capital.50 This is not necessarily a positive development, however, as ICOs have their shortcomings. Many ICO projects may never deliver any real results, and a few will be outright scams or frauds.51 Moreover, given the terms of some ICOs, these tokens may in fact constitute securities in a legal sense, meaning that, in order to be legal offerings, they must comply with the same disclosure and other regulatory requirements as traditional securities. Many ICOs are likely illegal given their failure to do so.52 But just as it was not worth abandoning joint stock companies as a financial tool because of early failures like the catastrophic Darien Scheme53 or frauds like ones that helped produce the South Seas bubble,54 the fact that an ICO can be misused or can fund a project that ends up being bungled does not mean that the instrument is itself necessarily flawed or irredeemably compromised. 50 The Economist. 9 November, 2017. “The meaning in the madness of initial coin offerings.” The Economist. https://www. economist.com/news/leaders/21731161-there-ico-bubble-it-holdsout-promise-something-important-meaning. 51 Higgins, S. 15 February, 2018. “CFTC Joins SEC In Warning Against Crypto Pump-and-Dumps.” Coindesk. https://www.coindesk. com/cftc-joins-sec-warning-crypto-pump-dumps/. 52 Rawle, G. and Rizvi, Z. 7 September, 2017. “Cooling the Blockchain Boom: CSA Staff Narrow the Path for Cryptocurrency Offerings.” Bulletin. Davies Ward Phillips & Vineberg LLP. https:// www.dwpv.com/en/Insights#/article/Publications/2017/CSA-StaffNarrow-Path-for-Cryptocurrency-Offerings. 53 Carroll, R. 11 September, 2007. “The sorry story of how Scotland lost its 17th century empire.” The Guardian. https://www. theguardian.com/uk/2007/sep/11/britishidentity.past. 54 President and Fellows of Harvard College. No date. “South Sea Bubble Short History.” South Sea Bubble Resources in the Kress Collection at Baker Library. Harvard Business School. https://www. library.hbs.edu/hc/ssb/history.html. ICOs are still a very new means of raising capital and thus it is not yet possible to know exactly which of their features will become significant. One example of how this innovation can create new types of economic relationships lies in the ability of platform and utility tokens to create new incentive structures for token holders – as opposed to the incentive structures that exist for holders of traditional securities. Indeed, contrary to a cryptocurrency, proponents argue that many tokens are better understood as similar to a license or a coupon that confers the holder with the right to use a company’s service or platform in the future.55 Because of how these utility tokens essentially represent IOUs for future services, they provide a built-in incentive to participate in the activities and communities that these tokens are associated with.56 By this logic, ICOs would be similar to “local currencies” – such as Ithaca HOURS – in that they fix value within a particular economic network in a way that helps build community, albeit in a non-geographical digital context.57 Some have argued these characteristics could help to reduce the sorts of short-term profit seeking that are exhibited by many of those who own traditional securities – a short-term focus that arguably encourages sub- 55 Adlerstein, D. and Tinianow, A. 21 April, 2018. “Why ICOs Could Eat Delaware’s Lunch.” Coindesk. https://www.coindesk.com/icos-eat-delawareslunch/. 56 Korjus, K. 19 December, 2017. “We’re planning to launch estcoin — and that’s only the start.” Republic of Estonia E-Residency Blog. Medium. https:// medium.com/e-residency-blog/were-planning-to-launch-estcoin-and-thats-only-the-start-310aba7f3790; Johnson, S. 16 January, 2018. “Beyond the Bitcoin Bubble.” The New York Times Magazine. https://www.nytimes. com/2018/01/16/magazine/beyond-the-bitcoin-bubble.html. 57 Jacob, J. Brinkerhoff, M. Jovic, E. Wheatley, G. 23 May, 2004. “The Social and Cultural Capital of Community Currency, An Ithaca HOURS Case Study Survey.” International Journal of Community Currency Research. 8. pp.42-56. https://ijccr.files.wordpress.com/2012/05/ijccr-vol-8-2004-4-jacob-et-al-2. pdf. See also Gilbert, K. 22 September, 2014. “Why Local Currencies Could Be On The Rise In The U.S. -- And Why It Matters.” Forbes. https://www.forbes. com/sites/katiegilbert/2014/09/22/why-local-currencies-could-be-on-therise-in-the-u-s-and-why-it-matters/2/#8279c837259a and De, N. 5 June, 2018. “Lawmaker Wants New York State to Pilot Local Cryptocurrencies.” Coindesk. https://www.coindesk.com/lawmaker-wants-new-york-state-to-pilot-localcryptocurrencies/. 58 Mougayar, W. 10 June, 2017. Tokenomics — A Business Guide to Token Usage, Utility and Value. Medium. https://medium.com/@wmougayar/ tokenomics-a-business-guide-to-token-usage-utility-and-value-b19242053416. 33 | THE MOWAT CENTRE optimal corporate decision-making.58 BOX 5 Smart Contract First articulated as a concept by Nick Szabo, a smart contract is a piece of software that encodes the terms of a contractual agreement and automates a part or the whole of its observation, verification and/or performance.59 Because they are written in computer code, smart contracts have the ability to be self-executing and self-enforcing.60 All that is needed is for the smart contract to be provided with the means of controlling the property implicated in the agreement, such as programmable digital assets or smart property (that is, physical property that can be controlled by software) and connected to the sources of information – often called “oracles” – required by the terms of the contract. The dimensions of the blockchain revolution ICOs are only one of a number of ways that blockchains can expand the space of possible economic relationships. Most of these new possibilities will likely have their impact along two dimensions of change, namely increased automation and decentralization. In both cases, the changes and new capabilities that blockchains enable will likely have impacts that spread beyond the economic sphere. Automation As with many other technological advances, some of the most important implications of blockchain will flow from the ways in which it enables automation. The most significant way that blockchain will likely do this derives from how its creation of a digitally native value system will enable the use of “smart contracts.” Before getting too far into a discussion of smart contracts, it is worth stepping back and considering what a traditional contract does. Currently, individuals or firms often create a contract to specify the parameters of an agreement between them. For example, contracts will often describe the services or products being purchased, the prices that have been agreed to, and the schedule for payments to be made. Signing a formal written contract is meant to clarify obligations between parties and to provide proof of an agreement that can be used to enforce compliance if 34 | INSIDE THE BLACK BLOCKS one party fails to meet their obligations. 59 Szabo, N. 1996. Smart Contracts: Building Blocks for Digital Markets. http:// www.fon.hum.uva.nl/rob/Courses/ InformationInSpeech/CDROM/Literature/ LOTwinterschool2006/szabo.best.vwh. net/smart_contracts_2.html. 60 Investopedia. No date. “Smart Contracts.” Investopedia. https://www. investopedia.com/terms/s/smartcontracts.asp. Significantly, the signing of a contract does not written in computer code has the ability to itself ensure compliance. Often services and remove much of the need for human intervention products are delivered that do not meet the in enforcement from the practice of contracting. agreed criteria, payments can be late and other conditions can be breached. It is true that the Consider the following example. Bob purchases existence of a contract entitles the parties to a car from Acme Motor Corp and agrees to apply to courts and the state for enforcement of make payments of one ether every month for 36 the terms of the agreement, but doing so often months. Bob and Acme Motor Corp can formalize involves lengthy and time-consuming litigation this agreement in a smart contract that runs on or negotiations.61 Moreover, in countries where the Ethereum blockchain and links their digital the rule of law is poorly observed, these problems wallets (the accounts that hold ether) and the car often multiply and satisfaction can be difficult itself to the smart contract over the Internet. This to obtain. Ultimately, contracting is always smart contract will monitor Bob’s payments and, an imperfect exercise that, while it helps to should he miss one beyond the limit specified in coordinate activities between counterparties and the smart contract, it could send a signal to the reduce risk, serves only to reduce, not eliminate, car locking its doors and disabling its engine until economic friction, risk and inefficiency. payments resume. Indeed, once autonomous vehicles arrive, the smart contract could even Smart contracts offer the possibility of further include a clause that commanded the car to reducing this inefficiency and risk by increasing return itself to the dealership if the purchaser predictability, thereby creating additional missed a sufficient number of payments.65 value.62 The creation of a digital value system enables smart contracts to accomplish this Setting aside the non-blockchain technological by expanding the boundaries of what can be innovations needed for this to occur (such as automated by increasing the ability of a contract the development of autonomous vehicles) what to directly exercise control over value.63 In other this scenario shows is how, by enabling smart words, by writing the terms of a contract into contracts, many systems could be rendered software that can directly perform these terms, much more efficient through the removal of smart contracting can reduce the risks of non- intermediaries. For instance, in this case, the compliance, while also increasing the speed and purchaser sets up a direct payment from their efficiency of the execution of the agreements digital wallet to the car company – thereby they implement.64 Essentially, a digital contract removing banks and credit card companies from this transaction. Moreover, the combination of smart contracts and smart property linked to this arrangement could remove the need for intermediaries like collections agencies to hound the purchaser and repossess the car if the purchaser was ultimately unable to pay. 65 In principle, these smart contracts need not benefit only large corporations. Smart contracts could also be created to enforce a car’s warrantee, thereby saving customers the need to badger an unresponsive manufacturer in order to have their rights enforced. 35 | THE MOWAT CENTRE 61 Wright, A. and de Filippi, P. 12 March, 2015. Decentralized Blockchain Technology and The Rise of Lex Cryptographia. SSRN. Page 25-26. 62 Szabo, N. 1996. Smart Contracts: Building Blocks for Digital Markets. http://www.fon.hum.uva.nl/rob/Courses/ InformationInSpeech/CDROM/Literature/LOTwinterschool2006/ szabo.best.vwh.net/smart_contracts_2.html. 63 Nick Szabo refers to this as an “embedding” of the contract in the world. http://www.fon.hum.uva.nl/rob/Courses/ InformationInSpeech/CDROM/Literature/LOTwinterschool2006/ szabo.best.vwh.net/smart_contracts_2.html. 64 Wright, A. and de Filippi, P. 12 March, 2015. Decentralized Blockchain Technology. Page 25. By extension, this could also enable the firms Blockchains offer critical functionality in this financing car purchases to lower the cost of regard. Recall that one of the key problems that financing because the costs associated with blockchains were created to solve was to enable defaults would be reduced. This reduction in the transactions – and, by extension, collaboration onerousness of financing might in turn lower the – between anonymous entities in a trustless number of defaults thereby creating a virtuous environment. This is exactly the situation that circle. By removing financial institutions from the will likely confront many autonomous devices equation, however, these smart contracts would as they seek to interact with other anonymous also result in lost jobs. autonomous devices – and humans – in the real world. Currently, we use economic value, and The implications of smart contracting are even exchanges thereof, as a means of coordinating more striking because of how, by enabling the allocation of scarce resources. Because this sort of automation, digitally native value of how blockchains enable the creation of systems could enable robots to begin contracting smart contracts capable of controlling digitally with each other autonomously. In so doing, native forms of value, one can imagine the blockchains may provide one of the critical establishment of dedicated blockchains technological advances that enables the supporting self-contained digital markets mainstreaming of the IoT. in a host of different contexts within which Currently, despite significant hype, the IoT has not yet noticeably impacted most people’s daily lives. There are a variety of reasons for this but some of the most important obstacles could be dissolved by the capabilities that blockchains offer. For example, IBM has suggested that blockchains will be essential to the deployment of the IoT because centralized command and control systems will be too complex, and by extension expensive and insecure, to maintain effectively when hundreds of billions, perhaps trillions, of devices will need to be connected remotely to these systems. Control will need to be decentralized and that likely means that the devices in question will need 36 | INSIDE THE BLACK BLOCKS to be autonomous – at least to a certain degree.66 autonomous devices would be able to interact and efficiently allocate scarce resources. In so doing, these automated markets could play the role of hyper-efficient coordination mechanisms that would likely generate significant new value. Why not just use a credit card? One might ask why some of the examples, such as Bob’s car payments, require a blockchain to function. Could not such a contract be programmed on existing technology? Perhaps it could: things that look a bit like smart contracting, such as algorithmic trading on the stock market, do already exist. Nonetheless, a number of important obstacles stand in the way of existing technologies supporting the mass proliferation of such systems. The most obvious of these obstacles is cost, something that is often a function of the presence of intermediaries. Currently, there are limited ways of transferring value electronically and they tend 66 Pureswaran, V. and Brody, P. with Cohn, J. Finn, P. Nair, S. Panikkar, S. 2015. Device democracy: Saving the future of the Internet of Things. IBM Institute for Business Value. Slides 3-5 and 7. to feature relatively high costs – especially when one considers the fees that intermediaries like banks and credit card networks charge both the micropayments directly to artists every time they customer and the merchant. One estimate made access their content instead of to intermediaries in 2016 suggested that the fees incurred carrying like record labels, iTunes or Spotify.69 out a Bitcoin transaction were 5.5 times lower than the same fees that would have been incurred using a credit card.67 It is difficult to imagine how existing credit card-based payment systems would be able to handle the volume of payments required to make The question of fees charged by intermediaries is these sorts of implementations possible. While an especially important one because some of the it is true that the most important blockchains more innovative implementations of blockchain currently have lower throughput capacity than that have been theorized would depend heavily credit card networks,70 upgrades – such as the on micropayments, often being made extremely use of state channels or ensuring interoperability frequently. In order for such implementations between multiple blockchains – are already well to be viable, high transaction throughputs at into development and testing.71 More important, very low cost would be necessary. For instance, however, is the idea that blockchain technology some have suggested that blockchains could could enable local or implementation-specific help to enable the implementation of smart blockchains to be created and optimized – electricity grids in which independently-owned relatively cheaply and flexibly on a per-project but autonomous home solar panel electricity basis – in ways that simply would not be possible generating systems negotiate with each other for the systems utilized by legacy payment and the larger grid, trading power between systems.72 them in real time.68 For these grids to function efficiently, a secure system capable of processing payments valued at the level of micro-cents Similarly, many have suggested that blockchains might enable revolutionary new forms of digital rights management for digital assets such as music based on the concept of ‘metered’ access to content that would involve users making 67 Hayes, A. 13 September, 2016. “How Much Cheaper are Bitcoin Fees than Credit Card Fees?” Investopedia. https://www. investopedia.com/news/how-much-cheaper-are-bitcoin-feescredit-card-fees/. Even at the height of the cryptocurrency frenzy in December 2017 and January 2018, fees on the bitcoin blockchain remained comparatively low. For example, on 22 December, 2017, the median fee paid to have a transaction processed was $31.71 (USD) and the median value transacted was $3,814 (USD) suggesting that the median rate being paid to transact on the network was about 0.8 per cent – still significantly lower than the standard fees charged by the major credit card networks. See https://bitinfocharts.com/comparison/bitcoin-median_transaction_ fee.html. 68 Kishewitsch, S. June 2017. “The promise of blockchain in distributed energy.” News. Association of Power Producers of Ontario. https://magazine.appro.org/news/ontario-news/51661498093738-the-promise-of-blockchain-in-distributed-energy.html. 69 Tapscott, D. and Tapscott, A. 22 March, 2017. “Blockchain Could Help Artists Profit More from Their Creative Works.” Harvard Business Review. https://hbr.org/2017/03/blockchain-could-helpartists-profit-more-from-their-creative-works. 70 Overcoming the hurdle posed by “scalability” remains an important challenge for public blockchains like Bitcoin and Ethereum. For example, Bitcoin can currently only process somewhere between 3.3 and 7 transactions per second, while Visa claimed in 2016 that its VisaNet system could process up to 65,000 transactions per second. See https://usa.visa.com/dam/ VCOM/download/corporate/media/visanet-technology/visa-netfact-sheet.pdf. 71 State channels are a mechanism whereby transactions can be carried out directly between parties without the need for the transactions to be conducted on the blockchain, thereby reducing the burden they impose on the network. Integrity of the transactions is guaranteed by a sort of “emergency break” which enables any of the parties involved to unilaterally move the transaction onto the blockchain at any time in a way that ensures that cheaters will not be rewarded. For a more in-depth explanation, please see Stark, J. 28 August, 2017. “Making Sense of Cryptoeconomics.” L4 Media. Medium. https://medium.com/l4media/making-sense-of-cryptoeconomics-c6455776669. 72 Kishewitsch, S. June 2017. “The promise of blockchain in distributed energy.” 37 | THE MOWAT CENTRE multiple times a second would be necessary. Decentralization Nonetheless, Ludwin still sees significant value The second main dimension along which creates what is referred to in the blockchain blockchain enables innovation and change community as “censorship resistance.” is decentralization. As discussed earlier, Censorship resistance is a term that refers decentralization is one of the key characteristics to a system’s imperviousness to unilateral of blockchain technology. But, unlike automation, alteration or control by a third party. In the case the opportunities offered by decentralization can of Bitcoin, this means that no third party can take more time to appreciate. Indeed, beyond the unilaterally intervene to stop a transaction from fact that decentralization makes blockchains being completed on the network. In the case of possible and that it increases their resilience Ethereum, it means that no entity can unilaterally and security, the most obvious implication of halt the performance of a smart contract running blockchain’s decentralization is that it creates on the platform.74 in blockchains because of how decentralization redundancy and inefficiency in systems that use blockchain. This inefficiency is often cited Censorship resistance is not important for as a problem for the expansion or scalability of everyone or at all times. To understand how it can blockchain-based systems like Bitcoin. In fact, become important, it is worth examining a recent Adam Ludwin, an entrepreneur working in the case where a centralized intermediated system blockchain industry argues that “on almost every engaged in censorship of its users. In 2010, all dimension, decentralized services are worse than major credit card companies, as well as Paypal, their centralized counterparts: refused to allow payments to Wikileaks over their » They are slower » They are more expensive networks, a move likely taken under pressure from the US government after Wikileaks released thousands of classified and secret US military » They are less scalable and diplomatic documents.75 While many might » They have worse user experiences applaud these firms for taking these actions on » They have volatile and uncertain governance.”73 the grounds that Wikileaks was irresponsibly releasing government secrets, many early Bitcoin adopters would likely see this as exactly the kind of authoritarian government action that Bitcoin 38 | INSIDE THE BLACK BLOCKS was created to frustrate. 73 Ludwin, A. 16 October, 2017. “A Letter to Jamie Dimon.” Chain. Medium. https://blog.chain.com/a-letter-to-jamie-dimonde89d417cb80. 74 This statement is true but obscures a slightly more complicated reality. See the discussion of “The DAO” in Section 6. 75 Poulson, K. 12 April, 2010. “PayPal Freezes WikiLeaks Account.” Wired. https://www.wired.com/2010/12/paypal-wikileaks/; Greenberg, A. 7 December, 2010. “Visa, MasterCard Move To Choke WikiLeaks.” Forbes. https://www.forbes.com/sites/ andygreenberg/2010/12/07/visa-mastercard-move-to-chokewikileaks/#522954382cad. Another example of the importance of central bank control of fiat currency was strong.80 censorship resistance can be found in the current Many believe that the key motivation behind enthusiasm for ICOs. As was discussed earlier, Bitcoin’s creation was to create a currency that ICOs have exploded in popularity and, in 2017, no entity could manipulate and debase in the attracted over $3.2 billion (USD) in investment. ways that governments and central banks have In fact, in 2017, ICOs provided more funding for often done throughout history.81 In fact, it is often Internet firms than did traditional early-stage said that Bitcoin first became popular in the venture capital. The funding for many of these places that needed it least because ensuring that projects would not have been available but for a currency is censorship resistant is not a priority blockchains because the alternative platforms, for many in a country like Canada where citizens such as stock markets, would decline to list them have benefited from a competent, professional and traditional investors would decline to fund and independent central bank.82 76 77 them.78 Setting aside the question of whether this is positive or not, the fact that blockchains like But cypherpunks’ concerns resonate powerfully Ethereum are enabling ICOs, and that there is little with those who have seen their life savings wiped regulators can do to stop them, demonstrates out by hyperinflation, have had them forcibly the extent to which blockchains are censorship converted into a new currency, or had access resistant.79 to their savings restricted by capital controls imposed by the government in places such A more fundamental form of censorship resistance can be illustrated with a comparison Blockchain was first proposed in the “cypherpunk” community where resentment of 76 The Economist. 9 November, 2017. “The meaning in the madness of initial coin offerings.” 77 Kharpal, A. 9 August, 2017. “Initial coin offerings have raised $1.2 billion and now surpass early stage VC funding.” CNBC. https://www.cnbc.com/2017/08/09/initial-coin-offerings-surpassearly-stage-venture-capital-funding.html. 78 Ludwin, A. 16 October, 2017. “A Letter to Jamie Dimon.” 79 The case of Plexcoin, one of the few ICOs where regulators have taken action, is instructive in this regard. Despite ordering Dominic Lacroix, its creator, to not go ahead with his planned ICO, Lacroix was still able to launch his ICO and collect more than $15 million dollars from investors before he was arrested and sentenced to jail time. Had Lacroix attempted to conduct a traditional IPO, the regulator would have been able to ensure that PlexCoin never hit the market. Pearson, J. 8 December, 2017. “PlexCoin Scam Founder Sentenced to Jail and Fined $10K.” Motherboard. Vice. https://motherboard.vice.com/en_us/article/ qvzkx7/plexcoin-scam-founder-sentenced-to-jail-and-fined-10k and Bergeron, Y. 8 December, 2017. “Le créateur d’une monnaie virtuelle condamné à la prison.” ICI * Quebec. http://ici.radio-canada. ca/nouvelle/1071971/peine-prison-createur-monnaie-virtuelledominic-lacroix It is also interesting to note that the only reason that Lacroix was caught and stopped was because he was charged by a Canadian authority while he was physically in Canada. More concerning are fraudulent ICOs launched from foreign jurisdictions where enforcement of Canadian laws may be impossible. 80 Indeed, sometimes these ideas can get a little strange: Pearson, J. 29 September 2017. “Inside the World of the ‘Bitcoin Carnivores’.” Motherboard. Vice. https://motherboard.vice.com/en_us/article/ ne74nw/inside-the-world-of-the-bitcoin-carnivores. 81 See for instance, Spiralus. 23 March, 2017. Satoshi’s Incomplete Economic Vision. Medium. https://medium.com/@ Spiralus/satoshis-incomplete-economic-vision-eb833a33bcb5 and Liu, A. 16 January, 2014. “What Satoshi Said: Understanding Bitcoin Through the Lens of Its Enigmatic Creator.” Motherboard Blog. Vice. https://motherboard.vice.com/en_us/article/vvbm43/quotes-fromsatoshi-understanding-bitcoin-through-the-lens-of-its-enigmaticcreator. 82 Popper, N. 29 April, 2015. “Can Bitcoin Conquer Argentina?” The New York Times Magazine. https://www.nytimes.com/2015/05/03/ magazine/how-bitcoin-is-disrupting-argentinas-economy.html Similarly, The creation of basic banking services for the world’s 5 billion unbanked individuals, something that has proven difficult or unattractive to traditional providers because of its low margins and limited profitability, is often touted as a potentially transformative application of blockchain that could make a material contribution to improving the lot of the world’s poor. Vigna, P. and Casey, M. 2016. The Age of Cryptocurrency. Page 186. Another example would be to provide reliable access to secure property rights for the two-thirds of the world’s population that currently live without them. See Vigna, P. and Casey, M. 2016. The Age of Cryptocurrency. Page 216-217. and Arsenault, C. 1 August, 2016. “Property rights for world’s poor could unlock trillions in ‘dead capital’: economist.” Reuters. https://www.reuters.com/article/us-global-landrightsdesoto/property-rights-for-worlds-poor-could-unlock-trillions-indead-capital-economist-idUSKCN10C1C1. 39 | THE MOWAT CENTRE between cryptocurrencies and fiat currencies. as Zimbabwe,83 Argentina,84 Venezuela85 and dollar bug bounty, and no one’s hacked it. It feels Greece. While Bitcoin is known for its own price like pretty good proof [that it is secure].”88 86 volatility, this volatility is arguably the result of its immaturity as an asset and will likely decrease Finally, some are arguing that the importance as it matures and grows more widespread.87 of decentralization is actually much more Conversely, inflation in a country like Zimbabwe abstract and fundamental. Those who make this is the direct and predictable result of the argument hold that the decentralization enabled government’s reckless decision to print money by blockchain is an essential corrective to a flaw to pay its debts. Inflation of this type would be in the current evolutionary path of the Internet. impossible in an economy that used only Bitcoin According to this argument, the lack of a protocol because the number of bitcoins is transparently for personal identification on the Internet has controlled by the Bitcoin software and resistant enabled the centralization of control over the to unilateral change (i.e. censorship) by a self- Internet into the hands of a small group of mega- interested party – like a profligate government companies with negative results for competition, looking to print its way out of its debts. users’ health and democracy.89 In combination with several other technologies, blockchain could Decentralization also helps make blockchains enable society to disintermediate these firms, reliable and secure. We have already discussed help to return the Internet to its decentralized how blockchains enable greater reliability origins and re-empower individuals by enabling because of how they eliminate single points them to own and better protect the data and value of failure. Similarly, by avoiding the creation of they create.90 “honeypots,” the use of a blockchain can increase security. Chris Dixon, a venture capitalist active in the blockchain industry, illustrates this point by comparing the value hosted on the biggest blockchains to a “bug bounty” – that is, the reward software firms will pay to hackers who inform them of vulnerabilities in their software. He notes that if someone were able to hack any of the big blockchains, the monetary reward would be immense – potentially worth billions of dollars. 40 | INSIDE THE BLACK BLOCKS But, “Bitcoin is now a nine-year-old multibillion83 Titcomb, J. 20 November, 2017. How bitcoin has become Zimbabwe’s crisis currency. The Telegraph. http://www.telegraph. co.uk/technology/2017/11/20/bitcoin-has-become-zimbabwescrisis-currency/. 84 Popper, N. 29 April, 2015. “Can Bitcoin Conquer Argentina?” 85 The Associated Press. 13 December, 2017. “Bitcoin boom seen as survival, not speculation, in Venezuela.” News. CBC. http://www. cbc.ca/news/world/venezuela-bitcoin-1.4447568. 86 The Associated Press. 29 June, 2015. “Greece in limbo as it shuts banks, puts limits on cash withdrawals to avoid financial collapse.” 87 Murphy, H. 27 November, 2017. “Bitcoin stirs volatility fears as it heads for $10,000.” The Financial Times. https://www.ft.com/ content/23392588-d398-11e7-8c9a-d9c0a5c8d5c9. 88 Johnson, S. 16 January, 2018. “Beyond the Bitcoin Bubble.” 89 The Economist. 18 January, 2018. “How to tame the tech titans.” The Economist. https://www.economist.com/news/ leaders/21735021-dominance-google-facebook-and-amazon-badconsumers-and-competition-how-tame. 90 Mainelli, M. 5 October, 2017. “Blockchain Could Help Us Reclaim Control of Our Personal Data.” Harvard Business Review. https://hbr.org/2017/10/smart-ledgers-can-help-us-reclaimcontrol-of-our-personal-data. 41 | THE MOWAT CENTRE One critical question that governments must constantly ask themselves is whether a blockchain is necessary or whether a simpler DLT – or even a traditional database – will suffice. 4 POTENTIAL USES BY THE BROADER PUBLIC SECTOR Some of the most interesting potential use cases for blockchain lie within the broader public sector. These use cases – which range from enabling greater effectiveness, patient control and privacy of medical records, to creating a reliable and accessible public record of individuals’ academic credentials to improving the efficiency of government business permit issuing and licensing regimes – all offer governments the possibility of improved transparency, efficiency and effectiveness. Nevertheless, all of these applications are still in the early stages and significant work remains to Electronic health records be done to ensure that any new solutions offer In the past few years a number of proposals for worthwhile improvements on existing systems. using blockchain to improve electronic health Blockchain is not a solution to all problems – or records (EHRs) have emerged. While initially even most problems for that matter. One critical pursued out of a desire to simply improve question that governments must constantly ask efficiency, EHRs are now also being seen as a themselves is whether a blockchain is necessary means of giving patients greater control over their or whether a simpler DLT – or even a traditional own health and medical treatments, something database – will suffice. In many cases, DLT and that is attractive from a privacy perspective but traditional databases will serve the government’s also because doing so seems to improve patients’ purpose more efficiently and effectively. health outcomes.91 Existing EHR systems aim Nevertheless, even with this healthy scepticism, blockchain offers governments numerous functionalities that could help them improve their operations. Consequently, they should 42 | INSIDE THE BLACK BLOCKS seize opportunities to experiment with potential to further these objectives, but for a variety of reasons including rigorous privacy requirements, poor interoperability, incompatible workflow designs and poor audit trails they have failed to deliver many of the sought-after improvements.92 uses of blockchain technology when they can. This section highlights three areas that hold significant promise or in which some governments are already active. 91 The Economist. 1 February, 2018. “A revolution in health care is coming.” The Economist. https://www.economist.com/news/ leaders/21736138-welcome-doctor-you-revolution-health-carecoming. 92 Halamka, J. Lippman, A. Ekblaw, A. 3 March, 2017. “The Potential for Blockchain to Transform Electronic Health Records.” Harvard Business Review. https://hbr.org/2017/03/the-potential-forblockchain-to-transform-electronic-health-records. The solution offered by blockchain would be to use a blockchain to create an overarching mechanism that would provide patients with a means of linking all their records, regardless of Professional and postsecondary credentials where they are stored, controlling who gets to Another area that offers a potentially important see them, and tracking their use. Critically, the use case for blockchain is in professional and EHRs themselves would probably not be put post-secondary accreditation. Currently, it can on the blockchain as is sometimes confusingly be frustrating, time-consuming and costly for suggested. Rather, the records would remain at individuals to prove that they hold the credentials the institution, be it a clinic or hospital, where that they claim to hold. Conversely, it can be just they currently reside, but access to these robustly as difficult for individuals to reliably confirm that encrypted records would only be possible through other individuals hold the credentials they claim a portal created by a blockchain. Access to the to hold. Many institutions that require individuals records would be controlled by the patient via to prove that they hold a credential still require the blockchain, and any access to the records them to do so by providing an original or validated would be tracked by the blockchain as would any physical copy of the credential. additions made to it. The process of proving one’s credentials can be The creation of a common, public, likely open- inefficient and costly, especially for refugees and sourced, EHR blockchain platform would provide skilled immigrants who otherwise need to go a single simplified focus for efforts to build through extensive testing to have their credentials compatibility into a system riddled with poor recognized or to establish new credentials.94 It interoperability. It could also conceivably enable can also be frustrating for students – especially massive new medical breakthroughs by providing international students – who may be required machine learning algorithms with a means of to purchase multiple copies of their transcripts using transparent, open source smart contracts or degree certificates from universities when to query millions of EHRs for specific pieces of they need them to apply for additional schooling, information without compromising the privacy scholarships or jobs. Moreover, it is difficult to of these records. In so doing, this could unlock reliably demonstrate the authenticity of many enormous new datasets for these algorithms to of these physical documents, making them mine for new discoveries and identify candidates vulnerable to fraud. for medical trials, potentially saving thousands of 93 See, for example, the proposal contained in Shrier, A. Chang, A. Diakun-Thibault, N. Forni, L. Landa, F. Mayo, J. van Riezen, R. Hardjono,T. Blockchain and Health IT: Algorithms, Privacy, and Data. White Paper prepared for Office of the National Coordinator for Health Information Technology U.S. Department of Health and Human Services. 94 The use of blockchain to overcome this problem is already being piloted: World Education Services. 30 May, 2018. “World Education Services Pilots Blockchain-Based Digital Badges for Internationally Educated Students and Professionals.” Globenewswire. https://globenewswire.com/newsrelease/2018/05/30/1513818/0/en/World-Education-ServicesPilots-Blockchain-Based-Digital-Badges-for-InternationallyEducated-Students-and-Professionals.html. 43 | THE MOWAT CENTRE lives and billions of dollars.93 The solution offered by blockchain or DLT would blockchain on which they issued the credential Government permits, licensing and “verifiable claims” granted to an individual in the form of a digital Finally, blockchain may prove extremely useful token. Individuals who received these credentials in improving the efficiency of government permit would be able to add the token to their digital granting, licensing and the provision of what wallet. If another institution or potential employer are referred to as “verifiable claims” such as an wanted to check an individual’s credentials, the individual’s date of birth. be for the credential granting institutions – such as universities, colleges or professional associations – to jointly operate a permissioned individual could simply provide the institution or employer with their wallet address for them to One of the most fundamental problems this query at any time. could solve would be to reduce the burden of interacting with government or complying with Not only would such a system increase efficiency, regulations currently faced by individuals and it would also make degree fraud much more businesses. Indeed, individuals and businesses difficult. This may seem like a small benefit, often complain that they are forced to waste but some experts claim that as many as half a significant amount of time by repeatedly of all PhDs issued in the USA each year come providing different parts or levels of government from fraudulent degree mills.95 Considering that with the same information that they have already credential requirements often play important roles provided to other parts or levels of government.97 in ensuring public safety and accountability for Not only is this inefficient, it creates a greater credential holders, such a system could reduce likelihood that this information will be hacked or some of the significant, but often unnoticed, corrupted through human error or technological harmful impacts of credential fraud.96 failure because it is being transmitted and physically entered into multiple systems multiple times. Blockchain offers a real opportunity to reduce some of these burdens for individuals and business. The Government of British Columbia’s Verified Organization Network (VON) represents a good example of how governments could use blockchain in this way. The provincial 44 | INSIDE THE BLACK BLOCKS government’s plan for VON is for government permits and other “verifiable claims” to be preloaded onto the system so that other government 95 Szeto, E. Vellani, N. “‘All of us can be harmed’: Investigation reveals hundreds of Canadians have phoney degrees.” Marketplace. CBC. http://www.cbc.ca/news/business/diploma-millsmarketplace-fake-degrees-1.4279513. 96 Johnson, E. 11 September, 2017. “‘I am devastated’: Toronto lawyer out $100K after hiring fraudster with fake law degree.” Go Public. CBC. http://www.cbc.ca/news/business/fake-torontolawyer-defrauds-clients-1.4276157. services can query the VON’s digital wallet, called TheOrgBook, to verify information about 97 Johal, S. and Urban, M. 11, May, 2017. Regulating Disruption: Governing in an era of rapid technological change. The Mowat Centre. https://mowatcentre.ca/regulating-disruption/. organizations on the network. Eventually, the Additionally, the project also included using ambition is for organizations like businesses an Ethereum test network to simulate how an to have their own wallets to hold their verifiable external entity – e.g., a bank evaluating a loan claims so that they will be able to prove their request from a potential restaurateur – might credentials to others themselves. access a public blockchain linked to a private 98 government one to confirm that the applicant In another similar example, the Government of had acquired the permits needed to open their Canada, the Government of Ontario and the City restaurant. The manner in which the blockchain of Toronto recently concluded a proof of concept was used, and the changes in the processes that in which they explored how blockchain might be it enabled are illustrated in Figures 13 and 14. used to improve the way governments interact with someone seeking to open a restaurant. The proof of concept demonstrated that there In this proof of concept, they created a test was significant scope for the use of blockchain database that was shared between a variety to improve the efficiency of the current customer of departments and agencies at the municipal journey from both the perspective of the applicant and provincial level with each of these entities and the various levels of government. For the operating one of the network’s nodes. This private customer, the use of blockchain or DLT in this test database never contained real individuals’ or way could reduce the burden of travelling to businesses’ information, but the database was many different government offices to acquire the used to simulate the movement of information necessary permits and cut the time required to needed to acquire a restaurant permit between do so from weeks to days. Note, for example, how the following portals and systems of record: the number of steps a citizen is required to take provide information and request incorporation of a new business » the Government of Ontario ONBIS registration system » the Canada Revenue Agency Business Number Registry System » the City of Toronto Licensing Office’s Progress Software Licensing System » the Alcohol and Gaming Commission of Ontario Computronix Regulatory Assurance System was cut from eight under the current system to four in the proof of concept. For governments, this sort of system could also help realize the ambition to create a more “client focused” approach to government services and also increase the integrity and security of the data involved while also reducing costs. Moreover, the proof of concept also demonstrated that it would be possible to introduce a blockchain or distributed ledger as just one piece that could help to connect the larger ecosystem of legacy systems. This is an important point to note as it means that blockchain or DLT could be implemented incrementally across the system as appropriate and in line with the lifecycles of existing legacy systems. In other words, a “Big 98 O’Donnell, D. 18 April, 2018. “BCGov Verifiable Organization Network – Impressive Client Demo.” Blog. Continuum Loop Inc. https://www.continuumloop.com/bcgov-verifiable-organizationnetwork/. Bang,” in which the entire system is replaced with a single blockchain at enormous cost and with significant risk, would not be necessary. 45 | THE MOWAT CENTRE » the Government of Ontario online portal used to FIGURE 13 Current restaurant permit acquisition journey Sara, who has never owned a business before, wants to open a restaurant. Follow Sara as she: 1 2 Opens an account with the ONBIS System Provides the required information so that she can: 1a incorporate her business register her business name receive a CRA business number The ONBIS System sends a request to the CRA BN Registry System. articles of incorporation business name registration CRA business number The ONBIS system sends Sara her: 1b 3 4 5 46 | INSIDE THE BLACK BLOCKS 6 7 8 visit the City of Toronto’s Licensing Office in person to apply for a preliminary zoning review and her municipal business license Sara must now take her new documentation and: Once the Licensing Office has physically verified her documentation, if everything is in order, Sara must now: Sara is granted a municipal business license and; provided with a preliminary zoning review apply for a liquor sales license from the Alcohol and Gaming Commission of Ontario (AGCO) by either mailing the documentation she has acquired or taking it with her as she visits the AGCO’s offices in person. Once the AGCO has physically verified her documentation, if everything is in order, After Sara has accumulated this documentation, she can now: Sara receives her loan and can now set up her restaurant. Sara is granted a liquor sales license visit a bank in person to present it as a part of her application for a loan. The CRA BN Registry System responds to the request by issuing a new CRA business number and sends it back to the ONBIS system. FIGURE 14 Potential restaurant permit acquisition journey Sara, who has never owned a business before, wants to open a restaurant. Follow Sara as she: 1 1a Sara opens an account with the Single Window Interface and provides the required information. When the application is completed and has been submitted it is automatically imported into the Data Exchange. The Single Window Interface: scans the application 1c Data Exchange Blockchain and smart contracts or other distributed ledge technology 1b After the smart contracts on the Data Exchange have scanned Sara’s application, they recognize that it should be sent to the ONBIS system so that Sara’s business can be incorporated and the business name registered. identiies all the permits that ensures that Sara has provided all the required information 2 3 With the business now incorporated and the business name now registered, ONBIS sends Sara’s application back to the Data Exchange. 1e Sara is notiied by the Single Window Interface that her application has been processed and that she has been granted all the permits she requires. Sara visits a bank branch to apply for a loan. After reviewing her application and granting Sara a business number, the CRA BN Registry System sends Sara’s application back to the Data Exchange. 1g After reviewing her application and granting Sara a municipal business license and a preliminary zoning review, Sara’s application is sent back to the Data Exchange. 1i 4 After reviewing her application and granting a liquor sales license, Sara’s application is sent back to the Data Exchange. Sara receives her loan and can now set up her restaurant. 3a The bank sends an inquiry to the Data Exchange to determine if Sara has the permits required to open the business associated with her loan application. 1d After the smart contracts on the Data Exchange have scanned the incomplete application, they recognize that it must now be sent to the CRA BN Registry System. 1f After the smart contracts on the Data Exchange have scanned Sara’s application, they recognize that it should now be sent to the City of Toronto to receive a municipal business license and a preliminary zoning review. 1h After the smart contracts on the data exchange have scanned the incomplete application, they recognize that it must now be sent to the Alcohol and Gaming Commission of Ontario (AGCO) to receive a liquor sales license. 1j After the smart contracts on the Data Exchange have scanned the now complete application, they recognize that Sara can be notiied that she has received all the required permits. 3b After scanning its records for veriication, the Data Exchange sends the bank conirmation that Sara possesses all the required permits. 47 | THE MOWAT CENTRE will be required The proof of concept also demonstrated that In this respect, proofs of concept and small scale while there would be some technical issues to pilot projects represent excellent opportunities to overcome, the largest challenges in implementing advance multiple objectives. As just mentioned, a blockchain solution would likely lie elsewhere. they can be leveraged to help build internal Specifically, while the blockchain itself would be government capacity without raising the tamper-proof and easily audited, it would only stakes too high. Significantly, these benefits be as good as the information added to it by the are also applicable for small and medium-sized participating departments and agencies and enterprises as well. These opportunities can the security of the processes by which these provide small and medium-sized blockchain additions were made. The type of data structures enterprises – of which there are many based used on the blockchain, the organizations allowed locally in Ontario and elsewhere in Canada – with to operate a node, the question of how new experience working with governments at a scale organizations would be on-boarded – all of these which is comfortable for them. This procurement questions would need to be resolved prior to experience can be especially valuable for firms implementation. Additionally, certain regulatory who often complain of an inability to attract and legislative requirements that are not critical institutional reference customers, even as technologically neutral may have to be changed they help to set up the government organizations before a blockchain or DLT-based solution could involved for future projects of greater scope and be implemented. ambition. On the human side, an external consultant was Overall, the proof of concept demonstrated contracted to provide much of the technical that there are real use cases for blockchain in know-how for the proof of concept. While government operations, especially as a means of some government employees were able to take encouraging and enabling cooperation between advantage of the project and use it as a learning different departments, agencies and levels of opportunity, getting to a point where government government that need to exchange information has sufficient in-house blockchain capacity to or verify claims with each other regularly. The tackle more ambitious projects will take time, proof of concept also demonstrated that there both on the technical and policy sides. could be significant benefits for the public should this technology be implemented by government in areas where there was a need for the public to be able to access data or prove a verifiable claim, such as their possession of a restaurant permit. But it also demonstrated that there 48 | INSIDE THE BLACK BLOCKS are significant obstacles on the path towards the implementation of an actual operational blockchain solution in government in Canada. 5 IMPLICATIONS FOR PUBLIC POLICY Blockchain is still a young technology and its implications for public policy are still unclear. Nevertheless, understanding how blockchain works, how it will enable more automation and decentralization and how it might impact government operations can help to reduce this uncertainty. Building on this analysis, the following section identifies four broad “Issues to Watch” which are likely to have important impacts in the context of public policy. Competition in “governance services” Many services that governments provide could land registry system onto a blockchain.101 Sweden conceivably be better delivered using blockchain recently completed a pilot project along similar or DLT. In some places this is already occurring. lines.102 The government of Dubai has said that The most obvious instance are in countries that it wants all visa applications, bill payments and lack stability or effective rule of law. For example, license renewals – processes which account in countries where the government has failed to for over 100 million documents per year – to provide a stable currency (such as Venezuela be transacted on blockchains by 2020.103 Each and, previously, Argentina100), many citizens of these projects have unique motivations are turning to, or have previously turned to, and contexts, but overall, the idea is that the cryptocurrencies. combination of transparency and immutability 99 extreme circumstances to provide governance services – often with governments playing a leading role. In 2017 the Eastern European country of Georgia began shifting its national 99 Chun, R. September, 2017. “Big in Venezuela: Bitcoin Mining.” The Atlantic. https://www.theatlantic.com/magazine/ archive/2017/09/big-in-venezuela/534177/. 100 Popper, N. 29 April, 2015. “Can Bitcoin Conquer Argentina?” 101 Shin, L. 7 February, 2017. “The First Government To Secure Land Titles On The Bitcoin Blockchain Expands Project.” Forbes. https://www.forbes.com/sites/laurashin/2017/02/07/the-firstgovernment-to-secure-land-titles-on-the-bitcoin-blockchainexpands-project/#1f4ecc134dcd; The Economist. 1 June, 2017. Governments may be big backers of the blockchain. The Economist. https://www.economist.com/news/business/21722869-antiestablishment-technology-faces-ironic-turn-fortune-governmentsmay-be-big-backers. 102 Haaramo, E. 5 July, 2017. “Sweden trials blockchain for land registry management.” ComputerWeekly.com. https://www. computerweekly.com/news/450421958/Sweden-trials-blockchainfor-land-registry-management. 103 D’Cunha, S. 18 December, 2017. Dubai Sets Its Sights On Becoming The World’s First Blockchain-Powered Government. Forbes. https://www.forbes.com/sites/suparnadutt/2017/12/18/ dubai-sets-sights-on-becoming-the-worlds-first-blockchainpowered-government/#4a56a414454b. 49 | THE MOWAT CENTRE Blockchains are also being used in other less offered by blockchains could help to improve the The most noticeable results of the X-road-led efficiency of government operations, the ease of digitization of government in Estonia have citizens’ interactions with their governments, and been the significant increases in administrative reduce opportunities for corruption. convenience and efficiency it has enabled. The Estonian government claims to have saved The Baltic country of Estonia is arguably the the equivalent of 2 per cent of GDP a year in country that is the furthest along this path. Its government spending. X-road information system enables residents to do everything from viewing their medical records, to paying their taxes, to voting online. But other more complex benefits also appear to 104 be emerging.107 For example, in 2014, Estonia Since the X-road only links a number of separate launched something called e-residency, a program centralized databases it is not itself a blockchain whereby non-Estonians can become “digital according to our definition. residents” of the country. E-residency, which 105 Nevertheless, it uses similar cryptographic techniques and DLT does not confer any special ability to actually to track changes to shared databases by multiple immigrate to Estonia, enables e-residents to collaborators, enable high levels of transparency access many of the services that Estonia’s and provide differentiated access to information increasingly digital government offers such as depending on permission levels. In fact, given the “remote management, lower cost of business nature of government operations, Estonia’s X-road services, access to the EU market, and access to may provide a better indication of what many of a wider choice of e-services.”108 the potential implementations of blockchain and DLT by government will look like than do public As of December 2017, almost 27,000 applications blockchains like Bitcoin.106 Thus, the Estonian for e-residency had been received from 143 experience offers a number of lessons and countries. At that time, e-residents had already insights into how government services can be set up 4,272 companies in Estonia. Furthermore, delivered more conveniently and efficiently using a 2017 report by Deloitte estimated that, in these sorts of technologies. It also offers some its first three years of operation, Estonia’s important warnings. e-residency program had generated €1.4 million in government revenues and €13 million in indirect socio-economic benefits. The same report suggested that these revenues and indirect benefits would likely rise to over €31 million and 50 | INSIDE THE BLACK BLOCKS €194 million respectively by 2021.109 104 Jaffe, E. 20 April, 2016. “How Estonia became a global model for e-government.” Side|Walk|Talk. Sidewalk Labs. https://medium. com/sidewalk-talk/how-estonia-became-a-global-model-for-egovernment-c12e5002d818. 105 Birch, D. 29 March, 2017. “The mystery of the non-existent Estonian digital identity blockchain: solved!” disruptive.asia. https:// disruptive.asia/estonian-digital-identity-blockchain/. 106 Note, for instance, the similarity of the X-road to the Government of Ontario and City of Toronto proof of concept outlined in Section 5. 107 Heller, N. 18 & 25 December, 2017. “Estonia, the Digital Republic.” The New Yorker. https://www.newyorker.com/ magazine/2017/12/18/estonia-the-digital-republic. 108 https://medium.com/e-residency-blog/heres-why-tax-evadersare-disappointed-in-estonian-e-residency-2322644f5f59. 109 Cavegn, D. (ed) 2 December, 2017. “Deloitte: E-residency brought €14.4 million to Estonia in first three years.” News. eer. ee. https://news.err.ee/646254/deloitte-e-residency-brought-14-4million-to-estonia-in-first-three-years. FIGURE 15 Estonia’s X-Road data exchange Source: Vassil, K. June 2015. “Estonian e-Government Ecosystem: Foundation, Applications, Outcomes.” World Development Report Background Paper. http://pubdocs.worldbank.org/en/165711456838073531/WDR16-BP-Estonian-eGov-ecosystem-Vassil.pdf. Page 12. At the moment, the advantages of e-residency – especially for marginalized groups like women that are often touted – such as the ability to use and especially when that business works across digital signatures for all business interactions, borders – the program has been very attractive. the ability to set up a company in hours instead Indeed, the e-residency program has partnered of days or weeks, the speed and ease of filing with the United Nations (UN) to develop a pre-populated smart tax forms and access to the project called “e-Trade for All” aimed at helping EU market – may not seem overwhelming from individuals in developing countries to start an a Canadian perspective.110 But for residents of online business using the e-residency program.111 some developing countries where regulations 110 The benefits are a bit more obvious for Briton’s who want to operate a business in the EU in a post-Brexit world. Hardy, A. Robinson, N. and Haggman, A. 18 November, 2016. “VISIT | How to stay in.eu: A post-Brexit gift from Estonia and an evening inside its Embassy.” Geopolitics & Security. Royal Holloway; University of London. https://rhulgeopolitics.wordpress.com/2016/11/18/visithow-to-stay-in-eu-a-post-brexit-gift-from-estonia-and-an-eveninginside-its-embassy/. 111 Godoy, D. 25 April, 2017. “UN and e-Residency join forces to empower entrepreneurs in the developing world.” Republic of Estonia E-Residency Blog. Medium. https://medium.com/eresidency-blog/un-and-e-residency-join-forces-to-empowerentrepreneurs-in-the-developing-world-ea834005f85e. 51 | THE MOWAT CENTRE can make it difficult to start and run businesses More fundamentally, e-residency shows how the It is not difficult to imagine how a welcoming digitization of Estonia’s governance services regulatory framework in a country like Estonia, has created the infrastructure needed to enable combined with the ability to remotely administer “government-as-a-platform.” a company through a program like e-residency, 112 E-residency is just one example of how the creation of platforms like might appeal to entrepreneurs.116 Indeed, one can this can enable the most unexpected innovations. see important parallels between this approach (Indeed, the next big step for the e-residency and the strategy used by the US state of Delaware program looks likely to be the launch its own to attract businesses to incorporate there in the blockchain-based digital asset, the Estcoin. ) twentieth century. By passing business friendly Critically, however, innovation like this is not just laws, by ensuring its Court of Chancery – a law the result of Estonia having built a technological court focused on business transactions – was infrastructure. Rather, the construction of a staffed with the best judges available and by corresponding “smart policy framework” building up a robust business case law, Delaware 113 114 – the policy culture and infrastructure needed to get an managed, despite its small population (still less optimal return from the technology and enable than a million), to become the legal US domicile innovations like e-residency – has also been of about two-thirds of all Fortune 500 companies essential. Overall, this smart policy framework (see Figure 15).117 has provided Estonia with a competitive head start in the race to attract businesses and investment, as well as “residents,” to its outsized corner of the growing digital world.115 Why is this important in the context of blockchain? By creating a digitally native value system, blockchain is enabling the digitization and automation of a vast new category of activities. In so doing, it is empowering individuals, firms and networks vis-à-vis the state in new ways and reducing the extent to which geography and borders can blunt 52 | INSIDE THE BLACK BLOCKS the competition that governments face. In 112 Government-as-a-platform is a concept patterned after the concept of Web 2.0. At its core, it refers to the idea that government’s function is as a convenor or enabler of beneficial forms of collective action. Thus, it refers to the idea that one of government’s core functions is to enable private individuals and groups to engage in beneficial activities that it would be difficult or impossible to undertake without government support – and which government itself is unlikely or poorly suited to do. For example, this often involves the creation of value through the leveraging of government data, as with citizen science initiatives or in building real-time transit tracking apps. See O’Reilly, T. “Chapter 2. Government as a platform.” Open Government. http://chimera.labs. oreilly.com/books/1234000000774/ch02.html. 113 Korjus, K. 19 December, 2017. “We’re planning to launch estcoin.” 114 Korjus, K. 7 July, 2017. “Welcome to the blockchain nation.” Republic of Estonia E-Residency Blog. https://medium.com/eresidency-blog/welcome-to-the-blockchain-nation-5d9b46c06fd4. 115 In another example, Estonians are also taking a leading role in grappling with the many legal issues that the development of artificial intelligence will raise – they even have a hashtag for it: #krattlaw. Heller, N. 18 & 25 December, 2017. “Estonia, the Digital Republic.” other words, individuals, networks, firms and governments in other jurisdictions now have the ability to compete with Canadian governments in the provision of governance services in ways that were simply not possible previously. With Bitcoin, a small network of individuals have shown that they are capable of disrupting an area – currency issuance – that has basically been a state monopoly for at least a century. How might 116 “Competition [between governments] is good. If you don’t offer good services, through e-residency, citizens will have options and can choose a better digital government”. See https://twitter.com/ AlexBenay/status/963166899314962432. 117 Semuels, A. October 3, 2016. “The Tiny State Whose Laws Affect Workers Everywhere.” The Atlantic. https://www.theatlantic. com/business/archive/2016/10/corporate-governance/502487/. FIGURE 16 Corporate domiciles of Fortune 500 companies in the USA 350 300 Number of companies 250 200 150 100 50 AR CA CT DE FL GA IL IN IO KY GA MD MA MI MN IA MO NE NV NJ NY NC OH OK OR PA TN TX UT VA WA WI Federal 0 Source: Semuels, A. October 3, 2016. “The Tiny State Whose Laws Affect Workers Everywhere.” The Atlantic. https://www.theatlantic.com/ business/archive/2016/10/corporate-governance/502487/. governments respond if, for example, significant banking will not be disrupted tomorrow,120 the portions of the economic activity occurring significance alone of such a possibility is so under their jurisdiction came to be conducted in great that prudence demands that governments a currency over which their monetary policy has build expertise in these new technologies and essentially no effect? consider how they might respond. Estonia and its 118 While unlikely to occur in the short term, challenges like these are not amenable to quick solutions – governments need to begin considering responses to contingencies of this nature well in advance.119 While fractional reserve e-governance infrastructure are providing an early and innocuous warning of how a government that embraces digitization can out-compete less innovative governments. (Estonia has committed to share all necessary tax information with the countries in which e-residents are physically active.121) While the details of the challenges presented by this increasingly competitive environment are not yet clear, the trend in this 120 Lagarde, C. 29 September, 2017. Central Banking and Fintech—A Brave New World. International Monetary Fund. Presentation made to the Bank of England Conference. London. https://www.imf.org/en/News/Articles/2017/09/28/sp092917central-banking-and-fintech-a-brave-new-world. 121 Anderson, J. 19 July, 2016. “One way to get around Brexit: Become an e-resident of Estonia.” Quartz. https://qz.com/736004/ one-way-to-get-around-brexit-become-an-e-resident-of-estonia/. 122 Hammersley, B. 27 March, 2017. “Concerned about Brexit? Why not become an e-resident of Estonia.” Wired. http://www. wired.co.uk/article/estonia-e-resident. For an example of an effort to effectively challenge government’s monopolies on a number of governance services, visit https://bitnation.co. 53 | THE MOWAT CENTRE direction is.122 118 For a more substantive discussion of the tax-specific implications of the transfer of value into digitally native value systems – one that has already started to occur with the advent of the “data economy” – see Johal, S. Thirgood, J. and Urban, M. with Alwani, K. and Dubrovinsky, M. 30 July, 2017. Robots, Revenues & Responses: Ontario and the Future of Work. The Mowat Centre. https://mowatcentre.ca/robots-revenues-responses/. Pages 35-36 and 38-41. 119 The Federal Reserve Bank of St Louis is already examining the potential problems such a situation could cause. Bullard, J. 14 May, 2018. Non-Uniform Currencies and Exchange Rate Chaos. Federal Reserve Bank of St Louis. Presentation made to Coindesk Consensus 2018. New York City. https://www.stlouisfed.org/~/ media/Files/PDFs/Bullard/remarks/2018/Bullard_Consensus_ New_York_14_May_2018.pdf?la=en. Decreasing effectiveness of “negative” regulatory frameworks The arrival of the Internet and streaming audio Another aspect of blockchain’s ability to empower and the Government of Canada have to date individuals vis-à-vis the state that is worth found no way of forcing these services to create watching concerns the declining effectiveness a guaranteed market for Canadian content. This of existing regulatory frameworks which have is largely because these services are based in traditionally relied on “negative” approaches. In other jurisdictions and are able to connect with our usage, negative approaches are ones that their users directly via the Internet. Without achieve their goals by removing or restricting restricting access to the Internet, something likely the freedom of individuals within the system. unacceptable to the public, it is not clear how the Positive approaches, conversely, seek to advance Canadian government could force these foreign an objective without restricting the freedom of firms to abide by its current Canadian content individuals. regime. The undermining of the federal government’s The key point to draw from this is that, as Canadian content regime for broadcast media by individuals are given more powerful tools and the Internet provides an example of this sort of more options, regulatory frameworks designed challenge. Previously, the Government of Canada to govern behaviours by coercively erecting was able to foster the production of Canadian barriers to block individuals and enterprises from cultural content by mandating that a percentage doing certain things will tend to be weakened. of broadcast content met certain criteria for By enabling streaming services, for instance, the Canadian-ness, such as the MAPL system for Internet has enabled many Canadians to opt out defining a Canadian song.123 The Canadian of the highly regulated Canadian broadcasting government was able to enforce this requirement industry, thereby undermining the ability of the because the Canadian Radio-television and negative Canadian content regulatory framework telecommunications Commission (CRTC), that governs it to achieve its goal of ensuring the the industry’s regulator, was able to monitor production of Canadian content. and video services has dramatically undermined the viability of this approach. Services like Netflix and Spotify, which an already significant and increasing proportion of Canadians use to access content, have no obligation to include Canadian content in their offerings and the CRTC 54 | INSIDE THE BLACK BLOCKS broadcasts and, if a broadcaster did not adhere to the policy, take corrective action such as fines or A parallel situation is playing out in the rush of the revocation of licenses. The logic of this policy investors keen to participate in unregulated ICOs was that by guaranteeing a market for Canadian based in foreign countries. Canadian securities content, the government was guaranteeing that regulators are now facing a similar challenge Canadian content would be produced. as the CRTC. Previously, these regulators relied to a large extent on their ability to control 123 Canadian Radio-television and Telecommunications Commission. 10 August, 2009. “The MAPL system - defining a Canadian song.” Content Made by Canadians. Government of Canada. https://crtc.gc.ca/eng/info_sht/r1.htm. what offerings were allowed to trade on stock exchanges to achieve their regulatory objectives. Now, this negative approach is being undermined. In such situations, governments are faced with achieve their goals more effectively. By offering or two options. First, they can double down on enabling the thing for which there is demand, but the negative approach and seek to improve doing so in a way that also allows the government its functioning by extending its rules, making to integrate safeguards or steer the activity in punishments more serious and increasing the its preferred direction, it may be better able to resources devoted to enforcement. In many achieve its ultimate objective through inducement cases, such an approach is unlikely to work rather than enforcement. well in a society like Canada that cherishes its liberties. Limiting access to the Internet, for example, would likely be decried as an authoritarian outrage. Novel legal questions As novel as many of these challenges are, they are at least recognizable to most policymakers. The other option is to use a proactive “positive” With Canadian content, for instance, governments approach where, instead of seeking to block have long pursued a dual-track approach that unwanted activities, governments take steps to mixes both negative and positive tools. Using encourage desired ones. In the case of Canadian more positive tools in response to the arrival content, such an approach would achieve the of streaming services represents a shift in policy’s objective – namely, the creation of emphasis, not a new departure. Canadian content – by proactively supporting the creation of Canadian content by, for example, Conversely, some of the most important providing funding directly to creators. challenges posed by blockchains will be the novel legal questions for which there are no In a blockchain context, such an approach real precedents. Or, as one author put it: “You might see the Bank of Canada responding to the think it’s hard to figure out what Bitcoin is popularity of cryptocurrencies by creating its from a regulatory standpoint, well, now we’re own cryptocurrency. Similarly, the Government talking about figuring out what an autonomous of Canada might respond to concerns about corporation is... [that’s] like something from The corporate (mis)uses of individuals’ data by Matrix.”125 creating its own blockchain-based digital identity as a foundation for a better digital Because of how they would remove the need rights management framework.124 While these for employees, officers and directors – and options are presented here as illustrations and even potentially owners – DAOs and DACs (see not recommendations the key underlying point Box 7; hereafter, we use DAO to include both) is critical, namely that by acting proactively, essentially reduce corporations to their legal governments and regulators can potentially skeleton, namely a set objectives, some business logic and agreements designed to achieve these objectives. When this is all encoded in software, it can become difficult to distinguish DAOs from computer programs like video games. But, unlike 125 Quoted in Vigna, P. and Casey, M. 2016. The Age of Cryptocurrency. pg. 241. 55 | THE MOWAT CENTRE 124 The United Kingdom (UK), for example, has taken steps in this direction. This program, called GOV.UK Verify, enables citizens to prove their identity online through the use of one of a few trusted private firms’ identity verification systems. Having done this, citizens can then use this verified digital identity to access government services, such as tax filing or checking the information on their driver’s license. Government Digital Service. 12 July, 2018. Guidance GOV.UK Verify. Government of the United Kingdom. https://www.gov.uk/government/publications/introducing-govukverify/introducing-govuk-verify. BOX 7 Distributed Autonomous Organization (DAO) or Corporation (DAC) current video games, DAOs could be completely decentralized, exist entirely on a blockchain, have no national domicile but still be able to act in the physical world. This is because control over digitally native assets could enable them 56 | INSIDE THE BLACK BLOCKS Traditional organizations or corporations consist of a Board of Directors that employs managers and other employees to pursue a specific mission according to a set of by-laws and within a business environment structured by laws, regulations and jurisprudence. The Board is accountable to members or shareholders for how well the corporation meets its goals which are usually set out in a mission statement – supplemented by legal and regulatory frameworks which further define its duties. A distributed autonomous organization (DAO) or corporation (DAC) is an entity that would replace the functions performed by the corporation’s by-laws, mission statement and employees – and potentially the Board – with a set of smart contracts that could control capital in a digitally native value system, collect information from prespecified sources via the Internet, analyze this information using machine learning algorithms. On the basis of this analysis the DAO/DAC would take actions, such as making investments, designed to advance its objectives within the applicable legal and regulatory frameworks. While functionally equivalent to a traditional corporation, the current legal status of such, still largely theoretical, entities is unclear.126 126 Malta has recently adopted a legal framework recognizing DAOs/DACs (which it refers to as “technological arrangements”) as similar to a traditional limited company with many of the same rights and duties. See Ronstedt, M. and Eggert, A. 4 July, 2018. “Among Blockchain-Friendly Jurisdictions, Malta Stands Out.” Coindesk. https://www.coindesk.com/among-blockchainfriendly-jurisdictions-malta-stands-out/. to purchase services or exercise control over Internet-connected devices like autonomous vehicles.127 Should such creations be allowed? If yes, how should they be regulated? How could such regulations be enforced? If not, how could one country stop them from acting within their borders? DAOs are only one of the more extreme potential applications of the much wider concept of smart contracts. Smart contracts are an innovation separate from blockchain but, because of how blockchain enables their more widespread and powerful deployment, they helpfully highlight the importance of approaching these interconnected technological innovations holistically. In fact, blockchainbased smart contracts are already beginning to appear: French insurer AXA recently tested an automated Ethereumenabled smart-contract-powered 127 Some thinkers have already suggested that such vehicles, legally owned by not-forprofit DAOs and directed by powerful machine learning algorithms, could be created and mandated to provide inexpensive mobility to marginalized communities. Kelion, L. 16 February, 2015. “Could driverless cars own themselves?” News. BBC. http://www.bbc.com/ news/technology-30998361. flight insurance policy that paid customers of algorithms to determine everything from who automatically if their flight was more than two gets a job interview or a car loan to the length of hours late. a convict’s sentence.130 We raise these questions 128 Smart contracts raise a number of important questions. Currently, the control of courts and quasi-judicial agencies by humans like judges enables human discretion and common sense to intervene in the performance of a contract if necessary, such as when extenuating or mitigating circumstances arise. If a contract is self-executing and hosted on a blockchain, however, it may be the case that nothing can be done to stop automatic performance of the contract – even if the results end up being monstrous, unintended or in conflict with other laws.129 For example, any contract agreed to under duress not out of alarmism: the posing of novel legal puzzles is a necessary corollary of the emergence of any new area or form of human activity. But it will take some time for courts, regulators and legislators to figure out the optimal governance frameworks for these areas. In order to minimize the harm that is caused during this period of transition, governments and regulators need to be thinking ahead, aggressively developing their own capacity, consulting with stakeholders, educating the public and actively piloting potential responses. would be a candidate for nullification by a court Governance of law. But, if uploaded as a smart contract for We described earlier how blockchains may performance on a domicile-less global blockchain, such nullification may not be possible even if backed by a court order. create competition for states in the market for governance services. While this certainly raises the question of how governments might compete Similarly, sometimes monetary compensation for with these new providers, it also raises the breach of contract may be a preferable alternative question of how these providers and services to performance by one of the parties. While it ought to be governed. may be possible to ensure options like this are written into smart contracts, it may be necessary to legally require inclusion of “escape clauses” of this type for them to actually be included given that increasing automaticity would likely represents one of the key motivations for using a smart contract. The infamous hack of “The DAO” in 2016 provides a helpful example of some of the issues that governments will need to think about in respect of blockchain governance.131 In this case, hackers exploited a flaw in the smart contracts that comprised “The DAO” – an autonomous corporation that had been built on top of the Other emerging challenges that blockchains Ethereum blockchain – and “tricked” it into could sharpen – especially when they intersect transferring around $55 million (USD) worth of questions of transparency and equity in the use 128 Higgins, S. 13 September, 2017. “AXA Is Using Ethereum’s Blockchain for a New Flight Insurance Product.” Coindesk. https:// www.coindesk.com/axa-using-ethereums-blockchain-new-flightinsurance-product/. 129 The authors thank Katie Szilagyi for bringing this issue to our attention. 130 See O’Neil, C. 2017. Weapons of Math Destruction: How Big Data Increases Inequality and Threatens Democracy. New York: Broadway Books. 131 Note, in this case “The DAO” refers to a specific decentralized autonomous corporation that was generically, and confusingly, named “The DAO”. 57 | THE MOWAT CENTRE with issues like automatic performance – include ether to an account they controlled.132 It’s likely that the hard fork was essentially analogous to that no laws were broken by the hackers because a mob-mandated retroactive changing of the law the creators of “The DAO” had specifically stated that constituted a theft of $55 million from the that the software that comprised “The DAO” was hackers who had done nothing wrong beyond itself the authoritative version of the contracts reading “The DAO’s” fine print more carefully than between the corporation and the investors and everyone else.134 This small minority argued that that any other information about the corporation, doing so betrayed the entire idea of censorship its purposes and its operations were superseded resistance and decided to continue using the by the logic encoded in this software. According old version of the Ethereum blockchain, which to this interpretation, anything the software was came to be called Ethereum Classic, on which the capable of doing would be, by definition, in line hackers were still in possession of the “stolen” with the contracts that governed “The DAO” and funds. thus legal. This controversy largely turns on the idea that the Nevertheless, investors in “The DAO” who lost entire point of an autonomous organization like money were understandably upset. Moreover, the “The DAO” is to remove arbitrary human decision- Ethereum community was very concerned that, making and recognize that “code is law.”135 despite the fact that the Ethereum platform itself Indeed, because code was meant to be law, the had not been compromised and was not at fault, need to hard fork the Ethereum blockchain was this incident would cause irreparable harm to the unexpected and the entire procedure by which larger Ethereum project simply by association. the decision was made was created on the fly The Ethereum community eventually decided to without any pre-existing agreed-upon governance “hard fork” the underlying Ethereum blockchain or decision-making processes. at a point prior to the hackers’ transfer of the contested funds to allow the former owners of the ether in question to recover it.133 Ethereum is not alone in having faced such problems. Bitcoin has also experienced a number disagreements – largely concerning whether This decision created a major controversy and block size should be increased – which have led resulted in a split of the Ethereum blockchain into to hard forks that have created alternate versions two distinct blockchains. Most miners and users of the currency such as Bitcoin Cash and Bitcoin agreed to move forward with the hard fork and Gold. While less acute than “The DAO” incident, the new version of Ethereum. A small minority of these conflicts also exposed a lack of governance miners and users balked, however, and suggested infrastructure in the Bitcoin community – at least 58 | INSIDE THE BLACK BLOCKS as governance is traditionally understood.136 132 The Economist. 25 June, 2016. “Theft is property.” The Economist. https://www.economist.com/news/finance-andeconomics/21701136-cyber-attacker-outsmarts-smart-contracttheft-property. 133 The “hard fork” described here is similar to the fork described in Section 3 except that in addition to going back in time on the blockchain and forking it at an earlier point in the record of transactions, this fork also involved simultaneously changing the underlying software that operated the blockchain. These sorts of changes to the blockchain’s operating software are called either “soft forks” – which refer to changes that maintain backwards compatibility with previous versions of the software – and “hard forks” which do not. 134 Schumpeter. 28 June, 2016. “Not-so-clever contracts.” The Economist. https://www.economist.com/news/ business/21702758-time-being-least-human-judgment-still-betterbet-cold-hearted. 135 Lessig, L. 1 January, 2000. “Code Is Law: On Liberty in Cyberspace.” Harvard Magazine. https://harvardmagazine. com/2000/01/code-is-law-html. 136 An account of Bitcoin’s “Civil War” can be found in Casey, M. and Vigna, P. 2018. The Truth Machine. Pages 71-79. Ultimately, all these controversies were resolved Moreover, even if they end up ceding the by having the users and miners decide for market for some “governance services” to new themselves which versions of these blockchains competitors, governments will not be able to they wanted to continue using. At one level this wash their hands of the need to ensure that is actually quite democratic – no one is forcing these services are delivered to their citizens in anyone to use any of these blockchains. But ways that adhere to constitutional requirements this emerging “vote with your feet” approach or obligations under international treaties. For to governance – which one can also discern in a variety of reasons, not everyone has the same e-residency’s limited empowering of individuals to ability to walk away and governments have a shop around for the government they like best – responsibility to ensure that these individuals are is a novel way to govern a community, at least in not inequitably disadvantaged, regardless of what a context where digital tools make it much easier others do. to implement than previously. While this might be exciting to some, especially libertarians, it’s pretty The questions raised by this incipient “vote with clear that governments are only just beginning your feet” approach to governance represent to think through the potential implications of the only a sub-set of a host of questions that could spread of this approach. be raised by the emergence of blockchain and to In fact, as blockchains continue to grow in size, instance might the “right to erasure” guaranteed importance, and ubiquity, governments may find by the EU’s General Data Protection Regulation that the use of a “vote with your feet” approach (GDPR) be given effect on an immutable public is not desirable in all cases of conflict with the blockchain? How should governments reach results of their own decision-making procedures accommodations with the private networks and political processes. Situations may arise that operate blockchains – or conceivably where they find they have a much stronger with non-human DAOs? Alternatively, how desire or need to become involved in blockchain might governments stop DAOs offering illegal governance. For instance, how large a proportion services via blockchain if these decentralized, of a country’s economic activity will need to be distributed entities have no national domicile? conducted using Bitcoin before that country While the answers to these questions remain decides it needs to find some way to exercise to be determined, one thing that is clear is that some control over the currency? If code is law, governments need to not only begin thinking then those who are impacted by the code will about them, but to also start actively working to eventually – and reasonably – want there to be shape the decisions that will need to be taken. a fair, predictable, transparent and democratic This will involve working to influence when these procedure for how that code can be changed questions make it onto the agenda and the fora in short of walking away from it. which decisions about them are taken. 59 | THE MOWAT CENTRE which governments will need to respond. How for 60 | INSIDE THE BLACK BLOCKS While blindly copying other jurisdictions is likely not the answer, changing the negative perception held by many blockchain innovators and entrepreneurs ought to be a priority for Canada’s governments and regulators. 6 RECOMMENDATIONS Developments in the blockchain community are moving very quickly. When we approached one blockchain entrepreneur for an interview, his response was to ask: “Why are you doing research so late in the game when there are lots of others that have done extensive research?” It was almost as if he was saying that if you are not already up to speed on blockchain, you might as well not even try to catch up. engagement with blockchain, this type of response Build internal capacity can be deflating and concerning. But, while it is Given that blockchain is such a new development, true that government has some catching up to do, it should not be surprising that the level of we suggest taking this quotation as we took it: as blockchain expertise and capacity within Canadian a reminder that events are moving fast and a spur governments and regulators is currently limited.137 to get a move on, certainly, but also as a reminder One of the first steps that governments need to of the need to be wary of some of the exuberance, take in preparing for the impacts of blockchain skewed perspectives and self-promotion that is to increase their own internal capacity. In the pervade the industry. first instance, this means building up groups In this final substantive section, we offer the of technologists and policymakers within following five recommendations to policymakers: government who understand the technology, its » Build internal capacity » Create an attractive environment for blockchain innovation » Support internal and allied experimentation » Make use of standards and other flexible tools » Foster national and global governance cooperation implications and the potential opportunities and challenges that flow from it. It is encouraging that Canadian governments are alive to this challenge and the need to increase their internal capacity. Indeed, many have already taken some important initial steps: » Innovation, Science and Economic Development Canada has been involved as a partner in blockchain proofs of concept and pilot projects Implementing these recommendations will help with a number of provincial and municipal governments capture the potential benefits government partners. offered by blockchain and avoid its pitfalls. 137 Stein, S. 14 February, 2018. “Blockchain engineers are in demand.” TechCrunch. https://techcrunch.com/2018/02/14/ blockchain-engineers-are-in-demand/. 61 | THE MOWAT CENTRE If this report represents your first thorough » Treasury Board Secretariat recently hosted a Government of Canada Blockchain Codefest and a Blockchain Day conference to advance the federal government’s understanding of the technology. » The National Research Council of Canada settlements process.139 These are all positive steps but they will need to continue and multiply. As we have previously recommended in the context of the relationship between government and disruptive technologies, has experimented with using the Ethereum proofs of concept and pilot projects140 – really blockchain as a way of executing and posting any initiative that provides hands-on experience grant and contribution agreements which it – are critically important to building capacity. already discloses publicly. Additionally, governments should pursue: » As discussed in section 5, the Government of Ontario and the City of Toronto ran a proof of concept designed to investigate potential uses of blockchain technology in increasing the ease of use and efficiency for the restaurant » Greater encouragement of secondments and interchanges with external blockchain and DLT firms and organizations by government staff. » Fellowships and other programs designed to permitting process. The Government of Ontario attract academics with blockchain expertise to also recently ran a blockchain hackathon work in the government for a set period of time. that generated a number of ideas for other » Specific, carefully designed and well-supported blockchain applications in government. programs for private sector technologists to do » As noted in section 5, the Government of a “tour of duty” in government for a set period of British Columbia will soon be launching its Verified Organization Network (VON) with time or for a specific blockchain or DLT project. » Greater encouragement of, and support for, the aim of putting government permits and existing government employees to pursue other “verifiable claims” on a blockchain and, educational leaves to upgrade their blockchain eventually, enabling individuals and businesses and DLT knowledge and skills. to use their own digital wallets to prove their credentials to third parties. » Project Jasper is a joint initiative between the Bank of Canada and a variety of other financial institutions and actors. Jasper’s first and second stages involved the building and testing of a “CADcoin,” a DLT-based interbank payments settlement instrument.138 Jasper’s third stage, 62 | INSIDE THE BLACK BLOCKS the use of DLT for improving the security on which the Bank of Canada is partnering with Payments Canada and Toronto Stock Exchange » Better integration of new learning opportunities like micro-credentials and nano-degrees targeted at enhancing government employees’ capacity in blockchain and DLT. Critically, these recommendations need to go beyond simply building internal technical capacity. While some technical capacity will be essential for governments to be able to identify, procure, implement and manage blockchain operator TMX Group Ltd, is focused on testing 138 Wilkins, C. 19 May, 2017. “Project Jasper: Lessons From Bank of Canada’s First Blockchain Project.” Coindesk. https://www. coindesk.com/project-jasper-lessons-bank-of-canada-blockchainproject/. 139 Reuters Staff. 17 October, 2017. “Bank of Canada, TMX to test blockchain for securities settlement.” Reuters. https://www.reuters. com/article/us-boc-tmx-grp-blockchain/bank-of-canada-tmx-totest-blockchain-for-securities-settlement-idUSKBN1CM30X. 140 Johal, S. and Urban, M. 11, May, 2017. Regulating Disruption. Pages 28-29. and DLT use cases in the public sector, many of Building a strong understanding of the non- the most important challenges this technology technical aspects of the technology will, creates lie in its implications for policy, regulation ultimately, be even more important for managing and the law. Not only does government need not just how government itself uses blockchain, to upgrade its technical capacity, it needs to but also how it modifies its policy, regulatory build familiarity and upgrade its understanding and legal frameworks to address the challenges of the technology’s non-technical implications and seize the opportunities that the technology throughout government and society. presents for society at large. Moreover, it is precisely these sorts of individuals who will be Given that governments exist in an environment critical to the successful implementation of many of fiscal restraint, building up the capacity of of our additional recommendations. those parts of government that will grapple with the challenges and opportunities associated with Finally, one of this report’s reviewers suggested blockchain’s emergence should be prioritized. that even before an organization starts to This list ought to include regulators that are build capacity, it is critical to ask “do we already confronting these new developments actually have a use case’ for blockchain? Is such as securities commissions, as well as those blockchain relevant to our work in a way that entities that have the most obvious immediate offers substantially superior results compared uses for the technology such as shared and to existing approaches?” These are critical government services agencies. questions to ask and it is true that not every government department or agency will require Given their central role supporting other in-house blockchain capacity. Awkwardly, being departments, central agencies should also able to answer these questions itself requires be a focus for capacity building, especially a significant level of blockchain expertise. This on the policy side. Existing policy innovation underlines the importance of government as organs, such as Ontario’s Policy Innovation Hub, a whole, and central agencies in particular, could even be directed to develop an internal developing nimble and re-deployable capacity government consultancy function to support able to facilitate the sorts of analyses which other parts of government. Finally, ensuring that individual departments and agencies that cannot senior executives understand blockchain at a (yet?) justify their own build-up of capacity will sufficient level so that they are able to effectively need. integrate blockchain and DLT-related policy advice 63 | THE MOWAT CENTRE into their decision-making will also be critical. Create an attractive environment for blockchain innovation to locate there. Not only do many local stores Even with a commitment to increasing town of just under 30,000 people.145 internal capacity, it is unrealistic to expect that government will be able to compete with the private sector for the best and brightest blockchain innovators.141 But, given the relative strength of Canada’s homegrown blockchain talent,142 Canadian governments have a good opportunity to build and support an innovative blockchain ecosystem in Canada. By doing so, and by building strong relationships with this sector, governments should be able to leverage this sector and its expertise in many of the ways described above. Successfully building and maintaining this sector, however, will depend on governments’ abilities to create an environment local government for many taxes and fees. Given this approach, it is not surprising that four out of 2017’s ten biggest ICOs were based in Zug – a Other jurisdictions are also staking claims to being one of the world’s blockchain hubs. For example, the US state of Delaware, seeking to build on its existing dominance in corporate formation and the expertise of its business courts, was the first jurisdiction in the world to explicitly allow corporations to maintain their corporate shares using a blockchain-based ledger.146 It is also looking at enabling the creation and maintenance of certain legal documents that often interact with shares on this blockchain and to enable shareholder voting through blockchain technology.147 capable of attracting blockchain entrepreneurs Encouragingly, Canadian governments and and innovators and retaining them. 143 regulators are trying to move in this direction. For Some other jurisdictions have already taken significant steps in this direction.144 The town of Zug in Switzerland has, for example, been dubbed “Crypto Valley” for its government’s enthusiasm for encouraging blockchain and related firms 64 | INSIDE THE BLACK BLOCKS accept payment in bitcoin, but so too does the 141 Indeed, demand “is off the charts” with “14 job openings for every one blockchain developer.” See Stein, S. 14 February, 2018. “Blockchain engineers are in demand.” 142 Canada was ranked third in terms of the number of blockchain start-ups behind the USA and the UK with the Toronto area accounting for much of this activity. Blatchford, A. 28 February, 2017. “Ottawa explores potential of ‘blockchain,’ billed as nextgeneration Internet tech.” The Toronto Star. https://www.thestar. com/business/2017/02/28/ottawa-explores-potential-ofblockchain-billed-as-next-generation-internet-tech.html. 143 In this light, the failure of the proposed blockchain supercluster application to even make the shortlist in the federal government’s supercluster selection process represents a missed opportunity. See https://www.canada.ca/en/innovationscience-economic-development/news/2017/10/innovation_ superclustersinitiativeshortlistofapplicants.html. 144 Popper, N. 29 July, 2018. “Have a Cryptocurrency Company? Bermuda, Malta or Gibraltar Wants You.” The New York Times. https://www.nytimes.com/2018/07/29/technology/ cryptocurrency-bermuda-malta-gibraltar.html. instance, the Canadian Securities Administrators (CSA) – an umbrella organization for Canada’s provincial and territorial securities regulators – has produced a number of staff notices to provide entrepreneurs and firms with insight into the evolution of regulators’ views. In its most recent notice, it even recognized the possibility of there being a difference between a utility token and a security token – a significant regulatory step.148 145 The Economist. 24 February, 2018. “A banking centre seeks to reinvent itself.” The Economist. https://www.economist.com/ finance-and-economics/2018/02/24/a-banking-centre-seeks-toreinvent-itself. 146 Adlerstein, D. and Tinianow, A. 21 April, 2018. “Why ICOs Could Eat Delaware’s Lunch.” 147 Stromberg, T. Negre, J. Reinhardt, M. Peleg, M. 23 March, 2018. “Are Headwinds Hampering Delaware’s Blockchain Initiative?” Law360. https://jenner.com/system/assets/ publications/17844/original/stromberg%20Law360%20March%20 23%202018.pdf?1521837416. 148 Canadian Securities Administrators. 11 June, 2018. “Securities Law Implications for Offerings of Tokens.” CSA Staff Notice 46-308. http://www.osc.gov.on.ca/en/SecuritiesLaw_csa_20180611_46308_securities-law-implications-for-offerings-of-tokens.htm. The CSA’s regulatory sandbox (see Box 8),149 is another good example of regulators seeking to be flexible and meet the needs of blockchain innovators. BOX 8 Regulatory Sandbox Despite these laudable efforts, Canada is not digital assets. Many of our interviewees who are active in the blockchain sector suggested that their interactions with Canadian governments and regulators had not been particularly encouraging. Some complained of delays and unresponsiveness from regulators as well as unclear guidance. One even suggested that by the time that this report was published, there was a good possibility that they would have moved to another, more supportive, jurisdiction.150 Another declared bluntly that “the brain drain is real” and that Canada has lost many of the advantages that it enjoyed in blockchain even just a few years ago. Unfortunately, even though the regulatory challenges posed by blockchain are not unique to Canada, the regulatory uncertainty that has persisted here has eroded some of Canada’s attractiveness among entrepreneurs. While blindly copying other jurisdictions is likely not the answer, changing the negative perception held by many blockchain innovators and entrepreneurs ought to be a priority for Canada’s governments and regulators.151 149 See https://www.securities-administrators.ca/industry_ resources.aspx?id=1588. 150 See also The Economist. 24 February, 2018. “A banking centre seeks to reinvent itself.” 151 To be fair, Canadian regulators’ responses to blockchain innovations are in line with Canada’s generally prudential approach to financial regulation, an approach that was much lauded during the most recent global financial crises. It may also be the case that some jurisdictions with more lax approaches are actually engaging in a “race to the bottom” and reducing their regulations imprudently. Thus, Canadian regulation of digital assets also likely represents, at least partially, a conscious decision to proceed with caution, even if it means losing out on some homegrown blockchain innovation. A program operated by a regulator which provides enrolled firms temporary exemptive relief from certain regulatory or legal requirements. The relief offered to firms is usually delimited in scope – up to a certain number of transactions or customers – or in duration. The purpose of a regulatory sandbox is to enable successful applicants to test new and potentially innovative and beneficial products and services whose development might otherwise be discouraged by existing regulatory or legal frameworks. Ideally, this relaxed regulatory environment will be coupled with tailored and ongoing engagement by the regulator with successful applicants as a means of facilitating innovation, protecting consumers and enabling regulators to learn about new innovations and potential regulatory changes they should consider. 65 | THE MOWAT CENTRE currently seen as a leader in the regulation of One way to build a more attractive environment still achieving the underlying objectives of the for innovation is to get more creative. One regulatory framework, namely to determine the interviewee suggested that one particularly useful level of the investor’s sophistication. way of doing this would be to try and find ways of aligning regulatory requirements for innovators This idea is not offered as a specific with the way that the “crypto community” itself recommendation, but as an illustration of the thinks about blockchain while still ensuring that sort of creative thinking being advocated. One the principles behind these regulatory regimes way to identify creative ideas like this would be were being applied. To see how this might be to increase efforts to build a strong network of accomplished, consider the following example. relationships between policymakers, regulators and entrepreneurs and technologists. Some Many financial institutions have a set of of the capacity building tools identified earlier, regulatory responsibilities collectively called specifically those that encourage exchanges “know your customer” (KYC). Depending on the of personnel like the successful Presidential product or service being offered, one part of KYC Innovation Fellows program in the US,152 could is a requirement for the institution to take steps to go a long way to building these relationships understand an investor’s strategies, expectations and a culture of innovation within government. and level of sophistication and to then tailor their While governments and regulators will often offerings to this customer accordingly. Currently, have different priorities and responsibilities such “client-onboarding” can take significant than entrepreneurs and should thus be wary time and involve questionnaires, the submission of regulatory capture, it is exactly these sorts of documentation and numerous other due of exchanges which could boost Canada’s diligence activities. Our interviewee suggested regulatory innovation and attractiveness.153 Such that a creative way for blockchain firms to fulfil insight will be especially important in the case some of their KYC requirements around investor of blockchain, given the many novel regulatory sophistication might be to allow firms to use challenges the technology will create. technical indicators to provide this information, an approach that aligns with a lot of current Another positive step that could be taken would thinking in the crypto community. be to create standing advisory committees 66 | INSIDE THE BLACK BLOCKS designed to bring industry, consumer, and For instance, if a buyer wanted to use a community members with a stake in specific cryptocurrency to purchase another crypto-asset, potential blockchain implementations into as opposed to a fiat currency-denominated credit contact with policymakers working in the space. card, this would be taken to indicate a higher These committees could offer technical advice, than average level of investor sophistication. The sector intelligence and serve as conduits to use by a buyer of a personal crypto-wallet in this additional expertise, as well as offering an transaction instead of an account at a crypto- important challenge function for proposed exchange would be taken to indicate an even higher level of sophistication. The motivation for using such an approach as a part of KYC due diligence would be that it could reduce the regulatory burden on firms and customers, while 152 Ehlinger, S. 9 January, 2017. “Effort to codify Presidential Innovation Fellows program is back in House.” Statescoop. https:// statescoop.com/effort-to-codify-presidential-innovation-fellowsprogram-is-back-in-house. 153 Johal, S. and Urban, M. 11, May, 2017. Regulating Disruption. Pages 18-19. government blockchain applications or policies. By piloting, governments could respond to Increased self-organization within the blockchain complaints like this and begin to build the industry could also help to provide government expertise and trust they need to move on to with a more robust interlocutor. larger partnerships in the future. Such an Support internal and allied experimentation As was highlighted earlier, one effective way for governments and regulators to build improved internal capacity and better relationships with stakeholders is to actively support the piloting of potential use cases of blockchain and DLT in the broader public sector. approach would also help to advance Canadian governments’ oft-stated desires to nurture homegrown technology start-ups and help these companies scale up their operations while remaining in Canada. Finally, it is important that governments do not attempt to develop large blockchain solutions aimed at replacing numerous legacy systems in a single “Big Bang.” As demonstrated by repeated failures, delivering massive information Supporting pilots might be especially productive technology systems of this type rarely works well at a local level or in partnership with a small set or stays on budget. Nimble approaches that start of connected institutions such as a hospital and with small scale tests and are designed to grow a network of medical clinics. By starting small, iteratively in ways that gradually integrate with governments limit risk and enable themselves procurement schedules and lifecycles of existing to develop internal expertise before the stakes systems are more likely to succeed. One of the become very high. Moreover, by starting local characteristics of blockchain and DLT that make but working collaboratively, these projects can them particularly suitable to such an approach help spread risk between the partners. This is is how they can be designed to connect to and important as some of the best candidates for coordinate other systems and expand organically the sorts of low-risk implementations ideal for over time, thereby avoiding the need for risky and piloting lie with municipal governments that highly complicated system-wide overhauls. might otherwise lack the funds or expertise needed. Federal and provincial governments would benefit from providing funds and expertise by gaining the opportunity to learn with only low levels of risk. These sorts of projects would also enable multiple levels of government to connect with sector firms and entrepreneurs. One of the complaints most often heard from technology entrepreneurs in Canada is that they lack large institutional reference customers like government – something they argue disadvantages them as they work to scale up their businesses. 67 | THE MOWAT CENTRE and gain experience collaborating with private Make greater use of standards and other flexible tools As was discussed in Section 4, blockchain will likely entail a reduction in the effectiveness of negative regulatory approaches and the emergence of several novel legal questions. For governments and regulators looking to protect the public interest in this changing environment, this will likely mean some shifts in emphasis and the adoption of some new tools. blockchain maintained by regulators. Standards might not be as effective as negative regulatory tools were in earlier times, but they would likely be much better than the current situation in which securities regulators’ ability to respond effectively to ICOs has been greatly impaired. Ideally standards could be developed in cooperation with organizations like the CSA and OSC. This is important because the reality is that there is a growing appetite for ICOs and there is little that regulators will be able to do to stop motivated individuals from participating in this One good example of a context in which new market. By reconsidering their approach instead tools are needed is ICOs. While many ICOs of sitting on the sidelines, regulators would be are helping innovators get their ideas off the able to offer some form of protection where ground, some are clearly frauds.154 Ostensibly, otherwise there would be none. While this may there are regulatory bodies such as the Ontario not be an ideal solution, it could at least help to Securities Commission (OSC) that are mandated rein in some of the excesses of the sector. to protect investors from these sorts of scams. But, given that many ICOs are both accessible via the Internet and based in other jurisdictions to which the OSC’s authority does not extend, it is essentially impossible for the OSC to use its traditional negative tools, such as fines or blocking the listing of a security on an exchange, to protect investors. 68 | INSIDE THE BLACK BLOCKS of accreditation could even be hosted on a public In addition to providing a helpful regulatory tool, standards will also be essential in ensuring that blockchain is able to reach its full potential in terms of impact. For instance, given some of the challenges around the scalability of public, permissionless blockchains, it is likely that there will be many, many blockchains operating in the future. In this context, blockchains The development of standards represents an will need to be compatible and interoperable alternative, positive approach worth exploring in order to maximize their usefulness. One in this regard. The idea would be to create and need look no further than the example of how publicize a standard that included a set of common protocols like TCP/IP were critical requirements around disclosure and reporting to unlocking the Internet’s potential in order that firms undertaking ICOs would need to to see the importance of interoperability. By meet in order to have their offering receive allowing different blockchains to integrate easily accreditation.155 A list of ICOs achieving this level with each other and enabling crypto assets to move between blockchains, the development 154 Matsakis, L. 30 January, 2018. “Cryptocurrency Scams Are Just Straight-up Trolling at this Point.” Wired. https://www.wired. com/story/cryptocurrency-scams-ico-trolling/. 155 In the UK, the TrustSeal standard has been developed along similar lines for accrediting firms offering sharing economy services. See https://sharingeconomytrustseal.com/about/. of widely accepted crypto-standards could play a significant role in unlocking blockchain’s full potential. One example of how this is already occurring Whatever standards are adopted, enforcement can be found in the creation of the ERC-20 token might require inventiveness. For instance, standard developed by the Ethereum Foundation regulators could consider working with – the body that more-or-less administers the academics to create open source algorithms Ethereum blockchain. The ERC-20 standard is the capable of scanning smart contracts for most popular standard for start-ups conducting adherence to specific standards. Blockchains an ICO. Given that the Ethereum Foundation that run smart contracts could also be explicitly is a not-for-profit foundation that is generally programmed to block the performance of perceived as playing a fairly benevolent role, there certain types of contractual terms.157 Whatever has not been too much concern about it playing the specific form it took, the key feature of a standard setting role so far. Regardless, as this approach would be to move away from blockchains like Ethereum grow in importance, unenforceable prohibitions and towards proactive governments will be forced to decide if they measures to provide individuals and firms with are willing to allow very new organizations, tools they could use to protect themselves. with unclear accountability structures and essentially no democratic legitimacy, to make very consequential decisions with little-tono opportunities for national governments to influence how these decisions are made. Foster national and global governance cooperation Farther along the line, governments will need to Blockchain is a global phenomenon and, confront some of the more novel legal questions consequently, a significant proportion of any that the development of a digitally native value successful attempt at governing it will necessarily system and the emergence of smart contracts take place at the global level. Unfortunately, entails. The creation of standards for smart the critical importance of improved national contracts, or even open source model contracts, and international cooperation by governments could be useful. Indeed, there are already and regulators is an area currently receiving examples to draw on. In the USA, the Mortgage insufficient attention. More governmental Industry Standards Maintenance Organization cooperation will be essential to overcoming some (MISMO) has created a set of standards that of the most important challenges that blockchain show how a specific form of legal contract can will create. independent organization that is scrutinized With regard to blockchain Canada currently by government or regulators to ensure respect faces three main challenges with international for the public good.156 In this approach, there dimensions. The first one is familiar: jurisdictional could be a requirement that any deviations from arbitrage. Jurisdictional arbitrage refers to how the model contract would need to be explicitly individuals, networks and firms can leverage signalled to the user and justified before the differences in jurisdictions’ regulations in ways contract could be signed. that advantage them, often at the expense of at 156 See http://www.mismo.org/. 157 This is arguably what occurred in “The DAO” debacle with Ethereum, though the decision not to enforce the terms of the contract was ad hoc and applied retroactively. 69 | THE MOWAT CENTRE be standardized under the supervision of an least one jurisdiction.158 A common example is These challenges will grow in importance as an for a firm to declare profits in one jurisdiction that increasing amount of financial activity moves were actually generated in a second jurisdiction out of national currencies and onto blockchain where a higher corporate tax rate was in effect. networks.162 While even perfect international This is already encouraging a sub-optimal race cooperation is unlikely to stop blockchains from to the bottom among jurisdictions as they being used for undesirable activities, individual attempt to attract firms by enacting lower and countries will find it extremely difficult to take lower tax rates and increasingly lax regulatory meaningful action against these activities environments that end up sacrificing the wider because of their distributed, even ephemeral, public interest. character.163 159 There may already be a race to the bottom taking place to attract blockchain firms, which is a problem in its own right. But, by The best hope governments have in this regard making it easier to move value around digitally, is working together and presenting as united a blockchains may also make it more difficult to front as possible. Thus, in addition to developing combat jurisdictional arbitrage by firms in other methods for regulating activities “on-chain” as sectors as well, worsening an already serious discussed in earlier subsections, governments problem.160 will also need to improve their ability to cooperate effectively “off-chain.” Second, the decentralized and distributed nature of blockchain makes it difficult for Third, just as the non-territorial nature of governments to combat undesirable forms of blockchains makes it difficult to negatively activity that use it, such as tax evasion or money enforce national laws, it also offers opportunities laundering.161 It also makes it difficult to impose for powerful governments to try and impose their requirements on blockchains that operate in preferred solutions extraterritorially across the other jurisdictions – such as the idea mentioned entire network by leveraging their “off-chain” earlier about disabling certain contractual terms. power. In other words, these governments may seek to develop standards that advantage them 70 | INSIDE THE BLACK BLOCKS and use their power in the physical world to 158 For a more in-depth discussion see Johal, S. et al. 30 July, 2017. Robots, Revenues & Responses. Pages 33-35. 159 The Organisation for Economic Cooperation and Development’s (OECD) Base Erosion and Profit Shifting (BEPS) task force estimates that these sorts of practices “cost countries 100240 billion USD in lost revenue annually, which is the equivalent to 4-10% of the global corporate income tax revenue.” G20 and OECD. July 2018. Inclusive Framework on BEPS: A global answer to a global issue. OECD. http://www.oecd.org/tax/flyer-inclusive-framework-onbeps.pdf. 160 A recent study found that “The average corporate tax rate globally has fallen by more than half over the past three decades, from 49 percent in 1985 to 24 percent in 2018.” Stein, J. 24 July, 2018. “Across the globe, taxes on corporations plummet.” The Washington Post. https://www.washingtonpost. com/business/2018/07/24/across-globe-taxes-corporationsplummet/?noredirect=on&utm_term=.1e9489353c71. 161 The Economist. 26 April, 2018. “Crypto money-laundering.” The Economist. https://www.economist.com/finance-andeconomics/2018/04/26/crypto-money-laundering. The head of Europol estimates that already 3-4% of criminal revenues in Europe is laundered through cryptocurrencies. impose or induce their acceptance globally. While having uniform standards might be desirable in abstract, Canadian citizens are unlikely to want to simply accept standards developed and unilaterally imposed on them by others without their input. To ensure that Canadian perspectives and interests are integrated into 162 Johal, S. et al. 30 July, 2017. Robots, Revenues & Responses. Pages 40-41. 163 A good example was the Spanish government’s inability to disrupt the online aspects of the referendum in Catalonia because of how the Catalan government used a decentralized protocol, the InterPlanetary File System (IPFS) to disseminate information about where and when to vote. Dedi, D. 23 October, 2017. “IPFS’s first win: the Catalan referendum.” CryptoInsider. https://cryptoinsider.com/ content/ipfs-first-win-the-catalan-referendum/index.html. the processes that produce these standards, standards for blockchain and DLT.166 From our Canadian governments, firms and non- interviews, we understand, albeit from second- governmental organizations need to be proactive hand sources, that Canada is participating in in engaging other interested parties and working this exercise but that the Canadians involved are constructively to fill the existing regulatory not receiving as much support as they ought to vacuum. be. Moreover, other interviewees suggested the ISO process may, ultimately, be of only marginal While concrete international action on blockchain importance. They suggest that governments is probably not yet warranted, countries like really need to get over their unwillingness to Canada should already be engaging like-minded get involved in the standards development work states in multilateral discussions on how to being done in “consortia” contexts – where small collaboratively solve the problems that blockchain groups of private firms develop standards – and will create. International organizations such as also begin to explore how they might interface the UN, the G20 and others could play a larger with the governance discussions occurring role in helping to create a consistent international around the most important public blockchains framework that can help limit a regulatory race like Ethereum and Bitcoin. to the bottom, keep these new technologies from contributing to problems like tax-base erosion, and ensure they contribute to the greater good.164 For example, the UN Commission on International Trade Law (UNCITRAL) could potentially serve as a good forum for the development and dissemination of “model laws” that address these problems or for preparing and building support for an international convention on blockchain governance.165 Additionally, Canada should ensure that its interests and perspectives are represented in any international exercises in standard setting. An ISO technical committee (ISC/TC-307), led by 164 See, for instance, Maupin, J. March 2017. “Blockchains and the G20: Building an Inclusive, Transparent and Accountable Digital Economy.” Policy Brief No. 101. CIGI. https://www. cigionline.org/sites/default/files/documents/PB%20no.101.pdf. At the moment, the G20 has not yet taken any concrete steps: Suberg, W. 23 July, 2018. “G20 Forum Shelves Deadline for ‘Very Specific Recommendations’ on Crypto.” CoinTelegraph. https:// cointelegraph.com/news/g20-forum-shelves-deadline-for-veryspecific-recommendations-on-crypto. 165 Models laws are legislative drafts developed by legal experts working for UNCITRAL and on the basis of the organization’s consultations with UN member states. States are invited to use these expertly-drafted model laws as the basis for national laws. See http://www.uncitral.org/uncitral/en/about_us.html. 166 These include standards on privacy, security, terminology, identify management, and smart contracting. See https://www.iso. org/committee/6266604.html. 71 | THE MOWAT CENTRE Standards Australia, is already working on ten 72 | INSIDE THE BLACK BLOCKS Over the time that this paper was researched and written, the price of a single bitcoin has gone from about $1,200 to over $25,000 and is now back to about $10,500 (CAD). 7 CONCLUSION As stated in the Introduction, this report is not designed to be a comprehensive discussion of blockchain or its applications. What it does aim to do is to provide policymakers with a fundamental understanding of the key concepts and the basic intellectual tools they will need to continue their exploration of this new technology with greater confidence. Thus, we close this report by summarizing the three key thematic takeaways from our research and by offering a gentle warning regarding the role that is being played by hype in the blockchain sector. Key Takeaways Blockchain can be a complicated topic and with 2] Blockchains and distributed ledgers also offer so much going on in terms of new ICOs launching, other less revolutionary, but still significant, companies and governments announcing new ways of organizing and coordinating proofs of concept, and enthusiasts offering information systems and tracking a variety fantastical speculations, identifying what is of assets. These implementations will enable important can be difficult. Our research has led greater efficiency and decentralization which us to believe that there are three fundamental could help secure greater privacy and a more conclusions that policymakers need to be aware even distribution of power in the digital era. of and need to integrate into their thinking: 3] The most significant implications of blockchain will arise from its interactions with other digitally native value system. Blockchains emerging technologies. For many of the most enable the creation of a digitally native value revolutionary impacts that commentators system which in turn lays the foundation for often predict for blockchain, blockchain will potentially revolutionary automation in new only be one of many contributing inputs. For areas. By enabling software to more easily example, when commentators get excited by manipulate value and by helping to make smart the possibility of blockchain-enhanced EHRs contracting much easier, blockchains will enabling massive medical breakthroughs enable software to do many new and important through vastly improved access to anonymized things that it cannot do today. patient medical data,167 the key development 167 Swan, M. 2015. Blockchain: Blueprint for a New Economy. Sebastopol, CA: O’Reilly. Page 62. 73 | THE MOWAT CENTRE 1] Blockchain marks the arrival of the first that will enable this probably lies with the since fallen back to about $600.168 Other less machine learning algorithms that will make well-known tokens have had even wilder rides the discoveries just as much as with the and overall, the fall back to less inflated prices blockchain technology which will organize the from the heights of speculation reached in early information and facilitate access to it. This January 2018 wiped out an astounding $500 pattern will likely be the same across many of billion (USD) in value worldwide in about one the possibilities described as being offered by month.169 blockchain. Thus, any effective government response will need to be holistic. It is very important for policymakers not to get distracted by this speculative rollercoaster. Naturally, there are many other issues related Blockchain and DLT offer many benefits, as to blockchain that will grow in importance in well as some real dangers, that are completely the future but which are not covered by this unconnected to the rise and fall of the price of a report. We hope that this report’s analysis of the bitcoin. At a deeper level, new technologies are fundamental concepts and questions raised by often buffeted by inflated expectations based on this new technology will leave readers better imperfect understandings, speculation and the prepared to ask the right questions and to simple inability to predict the future that even separate what is real from what is hype. the most visionary innovators cannot avoid. This Blinded by the hype? The question of hype is an important one to consider as we close this paper. When we began our research project in early 2017, many had already begun to see blockchain as something of yesterday’s news. At that time, AI and machine learning were the new hot topics that pattern has even been recognized and formalized as the “Hype Cycle” illustrated in Figure 17. FIGURE 17 The Gartner hype cycle Visibility Peak of Inflated Expectations everyone was talking about. Blockchain was Plateau of Productivity seen as increasingly passé and “so 2015.” But then, in the final third of 2017, the price of a variety of cryptocurrencies started to explode Slope of Enlightenment and it seemed like everyone was talking about blockchain again. Over the time that this paper was researched and written, the price of a single Trough of Disillusionment Technology Trigger Time 74 | INSIDE THE BLACK BLOCKS bitcoin has gone from about $1,200 to over $25,000 and is now back to about $10,500 (CAD). The fluctuation in the price of ether was even Source: Kemp, J. 27 December, 2007. File: Gartner Hype Cycle.svg. Wikimedia Commons. CC BY-SA 3.0. https://commons.wikimedia. org/w/index.php?curid=10547051. more significant with it starting 2017 at about $12.00 rising to more than $1,800 in the cryptomania of December 2017-January 2018. It has 168 All values as of 25 July, 2018. See https://ca.investing.com/ crypto/currencies. 169 Nishizawa, K. 6 February, 2018. “Get Ready for Most Cryptocurrencies to Hit Zero, Goldman Says.” Bloomberg. https:// www.bloomberg.com/news/articles/2018-02-07/get-ready-formost-cryptocurrencies-to-hit-zero-goldman-says. Given that blockchain seems to have gyrated In closing, we emphasize again just how up to multiple “Peaks of Inflated Expectations” essential it is to think of both the benefits and – largely on the back of cryptocurrency- and the challenges associated with blockchain as ICO-related financial speculation which has being inextricably linked with other emerging muddied public understanding of the underlying technological developments such as AI, big technology – it is hard to say where on this graph data and IoT. Because of this, it is essential that we currently find ourselves. The most likely policymakers be able to think of how they are point, however, is somewhere between the “Peak going to respond to these technologies in these of Inflated Expectations” and the “Trough of terms. The usual siloed government thinking, Disillusionment.” whereby one department or regulator assumes 170 This means that the next few years will likely be when we move onto the “Slope responsibility for one thing while another focuses of Enlightenment” and start to find out how useful on another without communicating very well and impactful blockchain will actually be. with each other, will end badly. Fortuitously, however, blockchain itself – and the transparency As this report has indicated, there are two main and cooperation it can enable – might just help categories of blockchain-related questions governments find a way to overcome this all-too- that policymakers face. The first concerns persistent bad habit. the impacts that this technology will have on the wider economy and society. The second concerns the potential uses that this new technology might serve for government in its own operations. To help policymakers answer both categories of questions, we have outlined a series of steps that governments ought to take, including building internal capacity, fostering an attractive environment for innovation, supporting experimentation with the technology, helping to fashion standards and flexible new tools to govern it, and working with other governments to develop the capacity to minimize its threats to 170 Gartner, the firm that developed the hype cycle concept, agrees with our assessment in terms of blockchain’s current positioning in the cycle. Panetta, K. 15 August, 2017. “Top Trends in the Gartner Hype Cycle for Emerging Technologies.” Gartner. https://www.gartner.com/smarterwithgartner/top-trends-in-thegartner-hype-cycle-for-emerging-technologies-2017/. 75 | THE MOWAT CENTRE their citizens and maximize its benefits.