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Legal issues that might arise for a blockchain-based start-up.

With the introduction of any new technology comes the uncertainty of how the legal and regulatory frameworks of various jurisdictions will handle the new technology. Electronic contracts’ enforceability and legality were in question up until a few years ago. Electronic contracts and digital signatures, on the other hand, are now accepted by the state governments of almost every state and are incorporated into their legal systems. For the purpose of regulating blockchain technology, the legislative procedure has already begun. States in the United States have passed legislation stating that records kept on the blockchain, and signatures made over the ledger shall be regarded as electronic records and electronic signatures, respectively. These states include Arizona and Tennessee. To regulate and formalise the way in which digital assets and digital currencies are handled using blockchain, India is now introducing a bill.

Before diving in headfirst, it’s crucial to be informed of the difficulties presented by blockchain technology, even though it has the potential to change company operations and transactions. If you want to grasp the legal concerns relating to the regulation of blockchain technology, this article is for you.

How do blockchains work?

Blockchain is the name given to a decentralised public ledger that enables data to be stored and digitally distributed across numerous computer networks that are connected in a peer-to-peer network. Its immutability (data cannot be changed or deleted), transparency, high security, expedited settlements, and decentralised nature set it apart from conventional electronic storage methods. These traits make it clear why businesses want to adopt this new technology and take advantage of its advantages.

Legal issues for blockchain based companies

• Jurisdictional issues:

As a decentralised ledger, the blockchain’s nodes can be found in numerous places all over the world. This implies that every transaction recorded on the blockchain may potentially be subject to the laws of every single state where a node of the network is located, thereby subjecting the blockchain network to an unmanageable amount of laws and regulations. It would be necessary for the system to adhere to all applicable legal and regulatory frameworks. This also makes it challenging to identify the location of a transaction if it turns out to be fraudulent or inaccurate in some other way.

• Governing Law:

The fundamental concepts of contract and legitimate title fluctuate according to the laws and regulations of various jurisdictions. What counts as a binding agreement in one state could be void in another. The law governing the transactions must be predetermined by an internal governance structure in order to prevent this confusion. The users would then be able to assess the legality of the contracts as well as their rights and duties thereunder. A method of dispute settlement that is acceptable to all parties concerned should also be specified.

• Cyber security concerns:

Although blockchain technology is thought to be extremely safe and “tamper-proof,” this benefit is lost if the data that is stored on the blockchain is compromised in the first place! Cybercriminals attack the data entry points rather than the ledger itself, which results in the storage of inaccurate or misleading information. When a 15-year-old boy from the UK created a proof-of-concept code that allowed backdoor access to hardware wallets, he demonstrated the viability of these types of attacks. Using this technique, attackers may change payment quantities and wallet destinations, even redirect payments to their own accounts covertly while making it appear as though the money had actually arrived in the target wallet.

A potential hazard in addition to the method mentioned above is brute force attacks. Typically, a small number of nodes dominate a blockchain system’s processing capacity. The ledger would be compromised if the attacker were able to pinpoint specific nodes and attack them. Aside from denial of service attacks, cryptocurrency exchanges are also susceptible to attacks like Eclipse or Sybil.

• Force majeure:

Typically, this clause in contracts covers situations that are beyond the control of the average person, such as wars, pandemics, natural catastrophes, fires, and the like. However, there might be additional legal considerations in the case of a blockchain-based system, such as a smart contract breaking, problems with cryptocurrency transfers, a party’s access to the blockchain being compromised, etc. Whether such occurrences qualify as force majeure events and whether parties may depend on them to avoid or postpone fulfilling their contractual duties must be made clear in the contract.

• Intellectual Property concerns:

The value and ownership of the intellectual property (“IP”) will unavoidably be a significant factor in the ledger. Customers can demand ownership of such intellectual property, licence it for the duration of the contract, or accept a perpetual licence if it is not proprietary to that specific blockchain network. They can also limit how long, to whom, or how the vendor may use the IP.

Virtual money and blockchain initiatives are primarily created under open-source licences. These licences often place some limitations on the users and are not commercial or subject to a royalty.

It is crucial for businesses to comprehend the restrictions of the open-source licence that has been provided to them and to protect themselves from any potential liabilities that may result from a violation of the licence terms.

To ensure that the business controls the intellectual property (IP) for the new technology, any new software advancements (such as mining, encryption techniques, payment systems, etc.) must be copyrighted. Start-ups using the blockchain must proactively file patent applications to protect the essential parts of their technology.

• Database as property:

While businesses often do not have IP rights over the individual pieces of information given to them, a database, or collection of data, is covered by IP rights in some jurisdictions. Under the Indian Copyright Act of 1957, databases are protected as literary works in India. Companies frequently send this type of data to other organisations, such their data processors, marketing firms, and other service providers, in order to store the information or to offer better services. In order to comply with the data protection laws in most jurisdictions, if the person or entity receiving the database chooses to use the information for a different purpose, they must first get the agreement of the individuals whose information will be used.

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• Data privacy concerns:

Although immutability is one of the fundamental features that makes blockchain valuable, it has a drawback. The blockchain is automatically deemed incompatible with data protection rules because data once saved on the ledger cannot be removed or altered (at least not easily). The “right to be forgotten” is protected by the EU’s General Data Protection Regulation, while California’s Consumer Protection Act likewise allows users the option to request that their data be changed or erased.

Additionally, it is said that cryptocurrency transactions are “pseudonymous” in nature, which means that even though the data points are not directly linked to a specific person, they can be linked together based on multiple appearances and different data points of that person. A person’s entire lifetime’s worth of anonymous transactions could be made public once the data is linked to them. As a result of the persistence of transaction history on the blockchain, this danger is certain to grow over time.

• Smart contracts:

Prewritten computer codes make up smart contracts. The contract’s conditions are laid down in terms of “if” and “otherwise.” These blockchain-based contracts automatically carry out when the required conditions are satisfied; a third party is not required to confirm the transaction. This calls into question whether such contracts can actually be enforced in court. There isn’t much room for discussion because everything is automated. It may also be necessary to take into account the elements of an offer, a valid acceptance, a consensus, consideration, etc.

It’s also likely that software developers may be held accountable for faulty coding that causes customers to lose money. This might happen as a result of a bug in the code or if it works differently than the parties to the transaction planned. Public blockchains for the DAO can also be compromised. In one such attack from 2016, the hacker shifted over $50 million in funds to a sub-contract under their control by focusing on the blockchain-based smart contracts. For such attacks, either the DAO or the code developer may be held accountable.

• Requirements for diligence:

It is necessary to modify the conventional due diligence procedures. Transactional attorneys who perform due diligence on investments in blockchain-based start-ups must be familiar with the cutting-edge technology and the special problems it raises, such as data ownership, intellectual property rights, open-source blockchain platform limitations, etc. These elements must be assessed in light of the business value proposition and entry barriers to competition.

• Antitrust considerations:

There is a risk of sensitive information being shared between competitors in the case of collaboration or joint ventures over a blockchain platform, which could lead to unfair business practises. Businesses must put protections in place to prevent the flow of sensitive data, such as restricting access to a block of data so that only the intended receivers can see its contents. It may be useful to aggregate or anonymize the private information saved on the blockchain to stop rivals from using it.

• Confidentiality concerns:

When it comes to multi-party blockchains, it must be made clear whether the receiving party’s addition of private information to the blockchain constitutes a violation or an allowed disclosure by the disclosing party. The clauses relating to the return and/or removal of confidential information upon the expiration of the term of an agreement must also be taken into account and modified in light of the immutability of blockchains.

• Virtual asset concerns:

A whole new set of issues develop if the blockchain system uses virtual assets to operate. Different jurisdictions have different laws governing cryptocurrency. While some nations have issued warnings about the volatile and unregulated nature of virtual currencies, many states have outright banned them. Only a few states, like El Salvador, have welcomed virtual currencies and accepted them as legal cash. It is also important to examine the taxes that are levied on these assets. In India, a 30% tax on the income derived from virtual assets has been implemented as part of the Union Budget 2022.

The explanation above makes it clear that any organisation planning to embrace blockchain technology faces a number of significant risk management challenges. But similar difficulties have been encountered before, during the introduction of e-commerce, electronic records, and the internet. Accurately identifying the dangers and legal concerns is crucial, as is properly mitigating them where practical. Companies using blockchain may also choose insurance to mitigate these legal concerns. Some of these risks may be covered by conventional insurances since cryptocurrencies are viewed as being equal to conventional assets like “securities” and “money.” To serve the cryptocurrency and blockchain business, some top insurers have also introduced specialist insurance products. Blockchain technology has many benefits that well surpass any potential hazards that may be involved, and businesses that use it now may benefit from it in the future.

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