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Episode 64 Buy Episode

Outsmarted? Blockchain, Smart Contracts and the Future of Lawyers

Law as stated: 28 October 2022 What is this? This episode was published and is accurate as at this date.
Steven Pettigrove of Piper Alderman joins Hearsay: The Legal Podcast to dissect the brave new world of distributed ledgers, blockchain, smart contracts and the role of lawyers.
Substantive Law Substantive Law
28 October 2022
Steven Pettigrove
Piper Alderman
1 hour = 1 CPD point
How does it work?
What area(s) of law does this episode consider?The background and regulation of blockchain and distributed ledger technologies, as well the role of lawyers.
Why is this topic relevant?Blockchain and digital ledger technologies have been quietly chipping away at a variety of different trust-related problems for industries as diverse as real estate, art, logistics, and legal practice. However, their meteoric rise in popularity has made it difficult for regulators to keep up.

Despite commentary to the contrary, lawyers-as-trusted-advisors play a key role in the development and function of distributed ledger and blockchain technologies – including cryptocurrencies – and will likely do so as new and novel structures such as DAOs gain legal recognition.

What legislation is considered in this episode?Corporations Act 2001 (Cth)
What are the main points?
  • Distributed ledgers have existed for a long time – including in the banking systems of the Roman Empire and Qing Dynasty.
  • Modern distributed ledger technology, with the assistance of computers, simultaneously records transactions and events across vast distances.
  • A blockchain is a form of distributed digital ledger that records every single transaction or event in a distributed and cryptographically signed ‘chain’.
  • Non Fungible Tokens (NFTs) are tokens whose purchase is recorded on a blockchain and which are intended as an expression of ownership of a specific piece of work.
  • Decentralised Autonomous Organisations (DAOs) are entities with no central governance where members own tokens which grant voting rights. DAOs are not currently recognised as legal entities in Australia.
  • Smart contracts are agreements executed on a blockchain which can programmatically execute once predetermined conditions are met.
  • Decentralised Finance (DeFi) describes emerging financial applications of blockchain technology. DeFI enables people to financially interact on a blockchain and do peer-to-peer transactions with one another, without the involvement of a traditional trusted third party.
  • ASIC has asserted that traditional cryptocurrencies are not considered financial products. To stop potential money laundering risks, Australia has made it a requirement to register and enroll with AUSTRAC when doing any conversion between fiat currency and digital currency.
  • The Australian government has just begun a token mapping exercise in response to recommendations made in the Bragg Report.
What are the practical takeaways?
  • If you wish to become involved in this area of the law, play around and become familiar with the technology in the crypto space. Spend time reading up on developments around the world in the crypto sphere because there are new regulatory developments every week.
How to:How to reconcile whether a cryptocurrency is a financial product:

  1. Ensure you understand all relevant details of the cryptocurrency or proposed crypto-product.
  2. Navigate to ASIC INFO 225 and reconcile those details against Parts C & D of the information sheet.
  3. Review the requirements of relevant legislation; including the Corporations Act and Australian Securities and Investments Commission Act 2001 (Cth).

For further details on ASIC INFO 225, listen to Steven’s episode from 33:51.

Show notesASIC Information Sheet 225

Final Report of Select Committee on Australia as a Technology and Financial Centre (Bragg Report)

David Turner:

 

 

 

 

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Hello and welcome to Hearsay the Legal Podcast, a CPD podcast that allows Australian lawyers to earn their CPD points on the go and at a time that suits them. I’m your host David Turner. Hearsay the Legal Podcast is proudly supported by Lext Australia. Lext’s mission is to improve user experiences in the law and legal services and Hearsay the Legal Podcast is how we’re improving the experience of CPD.

In the latter half of 2008, the mysterious Satoshi Nakamoto – a pseudonym whose owner has never been identified – published a white paper entitled “Bitcoin: A Peer-to-Peer Electronic Cash System. It was published in the aftermath of the Global Financial Crisis with the explicit purpose of removing that so-called trusted third party – banks and financial institutions – from electronic payment systems, at a time when trust in those parties had never been lower. Now, underlying Nakamoto’s vision was a technology known as blockchain, a solution founded on the use of distributed peer-to-peer ledger technology, cryptography, and digital signatures. Yet distributed ledger technology, of which blockchain is just one type, existed before the Bitcoin Whitepaper and, of greater relevance to lawyers, as far back as 1991 Haber and Stornetta published a paper titled “How To Time-Stamp a Digital Document” – that proposed a distributed method of signing digital documents, which relied on what we might now call metadata lifted from documents that were previously signed. Now, away from the mania surrounding Bitcoin and other cryptocurrencies, blockchain and DLTs are not so quietly chipping away at a variety of different trust-related problems for industries as diverse as real estate, art, logistics, and legal practice. So what makes a distributed ledger or a blockchain, how do they work? How are they regulated, if they are, and why are lawyers getting in on the game? With me today to discuss blockchain and distributed leisure technology is Steven Pettigrove, Special Counsel in Piper Alderman’s Blockchain Group and Financial Services and FinTech team. Steven, thank you for joining me on Hearsay the Legal Podcast.

Steven Pettigrove:Thanks, David. It is a great pleasure. Thanks very much for having me.
DT:Now, tell me how you came to be involved in this area of practice. What attracted you to blockchain and distributed ledger?
SP:

 

 

 

3:00

Look, I started my career as a litigation and regulatory lawyer. So, I always had that kind of financial services hat on, but also sort of problem solving for clients, whether it’s on the regulatory side or also thinking through sort of disputes issues. So, that’s where I started but somewhere along the journey, I got into startups, I think around 2014 and that was kind of my entry into the blockchain sphere. So, I actually co-founded a startup that was looking at potential use cases for blockchain technology in the supply chain space. So, we were thinking about how one could potentially verify wood or organic material in a kind of supply chain to verify the source of that and the sustainability of that and so, well, that’s kind of what got me interested in the technology. I read the Bitcoin White paper. I went along to the Melbourne Bitcoin Center back in 2015, which was a very sort of utopian place to be. The Bitcoin ATM was there and they help you set up a wallet and all of that sort of stuff and that was kind of where I got started but then, it’s kind of evolved over the years and once I saw DeFi, and I’m sure we’ll talk about that a little bit more in the podcast, I kind of got a sense of the power of the ecosystem that had been built. So, one can think of cryptocurrency almost as the base level infrastructure but now on top of that, with things like smart contracts dApps, or decentralised applications, we can start to see how that ecosystem has developed and how it’s possible to unlock a whole bunch of new use cases in a financial services space but also in many other realms of commercial activity or even community activity through blockchain technology and for me that’s when I went down the rabbit hole, as they say in the crypto world, which is basically really getting into blockchain. So, yeah, that was my journey.
DT: 4:00Yeah, I think those use cases, as you say, as infrastructure rather than as mere crypto-assets, is really the exciting edge of this technology and I should say that your insight about blockchain supply chain and logistics, well it, in the fullness of time, has proved to be true because some of the most successful applications of blockchain technology have been in the supply chain and logistics space. I know that our national supermarket chains and other large retailers are using blockchain based supply chain technologies now. And we absolutely will touch on DeFi a little later in the episode. Now, in your blockchain related legal practice, what kind of clients are coming to see you on a day to day basis? Are they founders of blockchain related startups? Are they large corporates who are looking for a way to use the technology in their existing businesses. Who are they?
SP:

 

 

5:00

It’s really broad actually. So, in Piper Alderman in the blockchain group, we face the industry as a whole and we look at basically the full gamut. So, everything from passionate young founders with, “hey, I’ve got this idea about a potential use case for blockchain technology” through to startups that aren’t really startups anymore, they’ve got a multi billion dollar valuation and a huge sort of global operation potentially. We do a lot of work with cryptocurrency exchanges, both local and overseas. We also work with funds who are investing in the space and increasingly we also field queries from, as you mentioned, institutional players sort of established institutions who are looking at potential applications of blockchain technology for their businesses
DT:So, not just a wide range of industries and use cases, but in fact really the whole ecosystem that surrounds blockchain technology.
SP:

 

 

 

 

6:00

Yeah, that’s right. I think one of the things that we really focus on at Piper Alderman is understanding the nature of our client’s business and understanding the nature of the technology and I think for a lot of clients, in this space at least, they don’t necessarily come from a traditional background and so understanding the way that they talk about the technology, I think is pretty important. So, that’s why we sort of organise it in that way rather than thinking about it necessarily as employment law blockchain or litigation blockchain. Although we do bring in expertise from different parts of the firm to help on different aspects of the projects and clients we work with.

TIP: What is a blockchain, you might ask? A blockchain is essentially a constantly growing list of records on a distributed digital ledger. A blockchain records every single transaction or event in a cryptographically signed ‘chain’.

Each event or transaction makes up a ‘block’ and is given a unique identifier. The ‘chain’ part of blockchain is a reference to the fact that each block references the block before it. As each block is reliant on information from the previous block, you can’t go in and alter any of the data on the chain once the event or transaction happens – barring some highly technical and usually hypothetical circumstances.

Cryptocurrency is an obvious example of a blockchain system, where the blocks are built from currency transactions. But there are other examples too. A blockchain is useful for documenting the provenance of a variety of goods – from artworks to all the way down to strawberries.

DT: 7:00Now, as I was preparing for our interview today, there’s an aspect of the intersection between blockchain and legal practice that really interests me and it’s that in the early 2010s there was an appeal of cryptocurrency to some users in that it was beyond the reach of the authorities that monitored transactions in fiat currency. Bitcoin was the de facto currency of drug exchange in the early 2010s and one of those early reasons why someone might have had a Bitcoin wallet was to buy something through a place like Silk Road and some of that anti-authority bent still prevails in some parts of the cryptocurrency communities. We see that with Bitcoin Maximalists, for example. Do you ever find that anti-authority and anti-regulation culture affects the way that some of your clients work in this area or the way that clients respond to advice?
SP: 8:00Yeah, it’s an interesting question, David. I mean, from my experience, our clients in this space are really acutely aware of the legal environment and they’re very interested in the legal environment. I think one of the features, at least these days, is that there’s actually a really high level of literacy around the regulatory environment. Even with some of the business folks that we deal with. There’s a lot of development globally. Basically every week there’s some new development that’s subject to really intense debate. We find that actually our clients are really interested in having conversations around those topics and what it means for their businesses. I think the points that you mentioned often I think in the early days of new technology, you do find lots of gray or use cases. There’s certainly illicit use cases for technology and I think we saw that in the early days of the internet as well. Another interesting aspect is the transparency of blockchain technology and it cuts both ways. So, in some ways you have the opportunity for bad actors to exploit the technology, but there’s also some aspects of the transparency of blockchain technology that make it harder for those sorts of activities to take place. So, it’s an interesting topic. I agree.
DT: 9:00That’s true and it’s great to hear that that stereotype, I suppose, about the attitude towards regulation and legal advice isn’t coming through in the clients that you are seeing. I suppose there’s a bit of a selection bias there in that the sorts of responsible clients who are getting advice from a lawyer who specialises in this area like yourself are probably not the kind who are dismissive or reckless about their legal obligations.
SP:Yeah, but I would still say as a whole, I think there’s a lot of interest in legal issues in this space, and I think people are thinking it through from the perspective of, if I wanna build a business in this area, how does the legal environment today impact that and what are developments that are coming down the pipe that might impact how I structure that business but there’s a huge amount going on globally in this space at the moment – lots of developments happening in the US and the EU – and that’s all going to impact the industry. So, people are starting to think through those questions as they start to formulate their ideas.
DT:

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11:00

Yeah, absolutely and I think there’s also a point to be made there that there’s a distinction between using a technology to facilitate something unlawful and using a technology on the edge as a form of kind of regulatory arbitrage for a legitimate purpose that regulation just hasn’t caught up to yet. I think as you’ve said, we’ve seen that with all sorts of new technologies, whether that’s gig economy platforms and taxi licensing, whether that’s Buy Now Pay Later as a form of alternative credit. We see that regulatory arbitrage with new technology, new business models, new innovations all the time. Speaking of the newness of distributed ledger technology, I wanted you to give us a bit of an idea of in what way blockchain as a form of distributed ledger is new because if you look back in history, there’s quite a lot of examples of distributed ledgers, even in ancient times. We have distributed ledgers that come into play in the ancient world before we had the ability to create reliable central repositories of information, the banking systems of the Roman Empire, the Qing Dynasty, even the 15th century Medicis, they all used a form of distributed ledger to transact across the distances that they had to deal with before telephony, before the internet. So, what is a digital distributed ledger and in modern day terms, why is that significant? What is the innovation that blockchain represents in terms of distributed ledger technology?
SP:

 

 

 

 

 

12:00

Sure. Look, if I had to boil it down to its simplest terms I would say that DLT is a sort of distributed database, which allows for simultaneous records updating access and verification. So, the difference perhaps between a ledger that was distributed hundreds of years ago and today is that all of that can take place digitally and in real time or very close to real time, which enables a huge amount of innovation because you then have this concept of digital scarcity, where something has value, which can be transferred between multiple parties and I think the other nature of it is perhaps, in times past, you would have a few trusted persons part of a network performing that sort of task. Now, you can actually have individuals who don’t know each other, who are located in different parts of the globe interacting and that’s a really powerful sort of extension, really, of the internet. I think it’ll be interesting to see in many new use cases as we see that technology applied in new ways.
DT:Yeah, and we’ve talked a little bit about those use cases already in art supply chain. We’ll come onto DeFi a bit later, but blockchain isn’t just relevant to finance or it’s not just used to generate crypto-assets like cryptocurrency or NFTs. Tell us a little bit about where you are seeing blockchain used in industries in use cases that maybe our listeners haven’t already heard about.
SP:

 

 

 

 

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Sure. Yeah. I mean we do a lot of work in the financial services space, but there’s a lot of other use cases out there as well. I think one of the really hot topics, at least in the last 18 months or so, has been NFTs and notwithstanding there’s been a little bit of a sell off in prices. There’s still a lot of new applications that we’re seeing coming through. I think one that your listeners will be very familiar with is the idea of digital art or you need digital art, yeah, and we’ve seen that in a lot of different instances over the last little while and some extraordinary prices for the sale of those sorts of things.

TIP: An NFT is a Non Fungible Token. You may be familiar with NFTs as images on the internet with excessive sale prices but, in fact, the opportunities NFTs provide are far broader than just digital media..

As the “non-fungible” part of NFT suggests, an NFT is a unique identifier unequivocally noted on a blockchain for posterity.

Another one that I’m sort of interested in is this idea of a POA, or a Proof of Attendance NFT, which basically, you know, you go along to an event, you scan a QR code and you get a unique confirmation or certification that you attended an event. So, there’s all sorts of potential application to that, thinking about things like ticketing and then other things you can potentially follow on. So, say you attended this event, “oh, you’re interested in X, therefore you might be interested in Y” or perhaps we want to turn this into a group and this group have a mutual shared interest. So, there’s lots of interesting new ways even of forming communities around these sorts of technology.

TIP: So Steven just mentioned Proof Of Attendance Non Fungible Tokens, or POA NFTs. These POA NFTs were initially introduced during ETHDenver in 2019. POA NFTs provide an easy way to collect and distribute digital collectibles at any type of event.

POA NFTs are minted through smart contracts as NFTs on the Ethereum blockchain. If you stick around, we’ll tell you what a smart contract is a bit later on in the episode.

For example, at crypto market operator Binance’s events, attendees can scan a QR code to claim their POA NFT for the event and open it on the Binance NFT marketplace.

Another interesting aspect of that is Decentralised Autonomous Organisations, or DAOs, I think have also had a bit of a moment in the last couple of years and it’s a bit of a broad and ambiguous term in some ways, and I think some people consider Bitcoin to be the kind of original DAO or the original community of decentralised persons working on a sort of shared technology platform but there’s a lot of other potential use cases for DAOs in the investment space but in other spaces as well. So, we saw last year one of the most prominent DAOs was a DAO called Constitution DAO in the US where a group of individuals came together to raise money to buy a copy of the US Constitution. They weren’t ultimately successful in that, but they managed to raise US$47 million in a very short space of time to do that and I think that’s an interesting example nevertheless of how, potentially, blockchain technology allows a group of potentially unconnected previously unknown individuals to come together for a particular purpose or cause. I think one of the things I’m really interested in is to see how that sort of technology is applied to potentially non-profit or other use cases going forward, whether it’s in a raising money context or a context of forming new aspects of community around the technology and I think, we’re really in the very, very early days of DAOs and thinking through the legal recognition aspect of that, the liability aspects of that and I think this is certainly going to be an area where people will be exploring in future years.

TIP: The battle for DAOs to become legally recognised is only in its early days, however, the state of Wyoming approved the first legally recognised DAO in the United States in July 2021.

A DAO called BLOCKS was the first DAO Limited Liability Company to be approved under Wyoming’s regime.

BLOCKS aims to onboard businesses and industry onto the blockchain so that they can benefit from a DAO structured environment. It also has its own governance token of the same name. Basically, it’s a DAO that helps other businesses structure as DAOs.

Steven will touch on the first-mover Wyoming in just a moment. Australia is yet to recognise any DAOs as legal entities.

DT: 17:00

 

 

 

 

 

 

 

18:00

Absolutely. Let’s talk a little bit about DAOs and then I’ll come back to NFTs. It’s interesting you mentioned the Constitution DAO because looking at that story for myself, I thought that was a great example of the dangers of having an organisation that is responsible for the pooled investments of a large number of people that doesn’t have adequate governance. I don’t remember if it was a Sotheby’s or a Christie’s auction, but I remember at the conclusion of the auction, some members of the DAO believed that they had won it. They opened an impromptu press conference to announce to the world, some very large media organisations, that they had successfully bought a copy of the US Constitution. During the conference, they were told that they hadn’t, that the person who they believed was their buyer’s agent was the agent for someone else and they then announced they were going to use the money to buy a basketball team which I don’t think they had really consulted the rest of the members of the DAO about. So, although it presents this opportunity for people who don’t know one another, who aren’t connected by a traditional network to pool assets to invest in a common purpose, is there a risk if regulation doesn’t keep up with innovations like DAOs, that we’re going to see these sorts of governance missteps, which would never happen or hopefully shouldn’t happen with a more traditional pooling structure like an MIS.
SP:

 

 

 

 

 

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I mean, I think, this comes back to being the really very early days of DAOs and there are a couple of aspects to your question. One is, working out the internal governance mechanisms of how DAOs work and sort of programming that within the digital infrastructure of it and thinking about the rights and liabilities attaching to individual members of the DAO. So, that’s the kind of internal governance piece of it, but then there’s the whole regulatory piece of it as well and so if you’re a participant in a DAO, what is your legal liability? This is still very much a topic of legal and academic debate, and the most famous example of this is people thinking about whether or not it might be an unincorporated association or a partnership that’s hasn’t had any legal Identity attached to it yet and so those sorts of risks are still, I think, very much to be confirmed. There’s been an absence of either regulation or litigation around those sorts of issues yet, and I think, those are the sorts of areas where it’s gonna take a little bit of time for people to figure out, okay, what’s the right model for governance for a DAO and different types of use cases and I think we’ll probably see different types of models emerge that tend to be better than others and similarly, on the legal side, I think, people are still working out as well. Is it appropriate to have some form of limited legal liability around DAOs? So, one of the very early movers in this space has been the US state of Wyoming, which has taken steps to recognise DAOs as a form of legal entity. There are some issues around that and some people think that’s not where we want to be going – imposing that legal infrastructure over the top of it, because there are other things that come along with that as well in terms of, if you have a central legal identity, then you have things like tax liabilities and all sorts of other reporting liabilities that will come along with that but the flip side of it is that potentially it gives people some security around what their potential liability is by participating in a DAO, it allows the DAO to do certain things in a real world capacity in terms of opening a bank account, for example, if that’s something that they feel they need. If you’re organising real world events, then potentially some form of legal entity or protection might be appropriate for the organisers of those events. My own view is that I don’t think there’ll be one single model that wins out. I think there’ll be a variety of models and it will very much depend on who you are and what you’re trying to achieve but, I think, what’s potentially very powerful is that idea that you can organise people online who don’t necessarily know each other or do potentially in new ways and very quickly and I think it’ll be fascinating honestly to watch how that all plays out
DT:

 

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Absolutely and I think, distinguishing the technology from the organisation, you can really see the capability of that DAO technology as an enabler for greater shareholder participation. In small public companies, for example, that might be an effective way of empowering shareholders to play a greater and more active and more regular role in the governance of the company in which they’re invested. Going back to NFTs though, I love your example about the POA because it’s a great example of a utility based NFT. Can you tell us a little bit about the difference between NFTs that have utility and NFTs that don’t, because it seems like the shocks we’ve seen to price in the NFT market really have been in relation to NFTs that don’t have utility, that are in the kind of digital art space.
SP:It goes back almost to the essence of what is art, right?
DT:Yes. Yeah.
SP:These questions aren’t sort of unique necessarily even to technology or NFTs. I think what has utility and what has use is very much sometimes in the eye of the beholder and so…
DT:That’s very true.
SP:

 

22:00

… what one person sees as a copy paste JPG, another person sees, as, a work of high art that’s valued at multiple millions. So, yeah, that’s a bit of a glib answer but to break it down a little bit more, what we’re seeing is a really wide potential use of NFTs in different ways. So, the ticketing example is one example but you’ve also got the art example. We’re seeing them in financial use cases as well now. So, one of the very well known decentralised exchanges called Uniswap in their latest version of this decentralised exchange are using NFTs to represent liquidity positions. So, if you put cryptocurrency in to provide liquidity for the exchange, then you’ll get an NFT, which you can potentially trade and represents your liquidity position in that DAO and I think we’ll also see other use cases as well. One of the interesting developments recently there’s been an announcement of a new token standard for Ethereum, which will allow for renting tokens potentially. So, it’ll be interesting to see how that all plays out. I think that proposal’s just been approved, so we haven’t seen too much on that front yet, but it’ll be interesting to see how that all plays out.
DT:

23:00

I’m really interested in these use cases that aren’t about price speculation. I think when someone who’s not overly familiar with the sector thinks of an NFT, they think of a Bored Ape or a Cryptopunk or a digital asset that is highly volatile in price that you kind of gamble with but your ticketing example, the art provenance example, which I think is a fantastic use case for NFTs given that, I think the estimates are something like half of the art hanging on public gallery walls is probably not by the attributed artist. Solving that provenance issue is a really interesting use case. The ones that don’t concern resale of the asset for a profit, I think are fascinating.
SP:

 

 

 

24:00

Yeah, I think another one potentially is music as well. For artists to use the same sorts of technology to create and release music or to fund music projects and that has its own regulatory issues around it as well but I think what’s powerful about it is that it’s potentially taking out intermediaries and allowing artists and creators to directly access the market in a way that at the moment they sort of all have to go through, whether it’s iTunes or Spotify. This potentially allows them to access new markets more directly and hopefully more efficiently. Now, you still have NFT marketplaces, like OpenSea’s a very well known one, there are others as well, but the idea is that, for artists and creators, this is going to be a way for them to access a global marketplace much more quickly, but also hopefully gain a bigger and a better share of the profits of their creativity.
DT:Absolutely. Now, there’s one concept I wanted to discuss that’s sort of blockchain adjacent, which is the concept of smart contracts as an abstract concept that’s not necessarily blockchain exclusive, but some of the most common implementation of smart contracts we see today is using the Ethereum network. Can you tell us a little bit about what a smart contract is and how it relates to blockchain and, specifically, the cryptocurrency Ethereum?
SP:

 

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So, smart contracts, to sort of boil it down, are basically soft applications which execute on a blockchain. So, it’s the ability to create, effectively, a program that has a specific outcome if certain predetermined terms and conditions are met. So, not unlike a contract where you specify, “hey, if X happens, then A will pay B”, you can do the same thing, but effectively encode it into the blockchain and what’s special about that, as opposed to just being an ordinary software application, buying it from Microsoft or whatever the case may be, is that the actual settlement infrastructure happens on the blockchain. So, someone is able to go in and interrogate how the smart contract works, but the actual settlement of it happens programmatically through that distributed ledger technology and so that really unlocks the capability for two parties who don’t necessarily know each other, we’re sort of talking about the same thing again, to be able to interact and trust one another and transfer value and the other aspect is the crypto. So, the cryptocurrency bit is, in a way, vital for that because if you don’t have that ability to transfer value in some way, then you don’t have the ability to execute it on the distributed ledger and so whether it’s stable coins or some other type of digital asset that is really a key component of what unlocks smart contracts. I think the topic, again, is a really interesting one for a few reasons and I think one of those reasons is the use of the word smart contract itself is I think, a little bit controversial as to whether or not these really are contracts in the sense that we’ve traditionally understood them or whether there’s some limitations around that and certainly, we see examples almost every day where people are actually arguing with the smart contract, if you like, as to whether that was exactly what was intended to be the outcome. So, take for an example where there’s a hack or some sort of error in the code, in something that’s released that results in an outcome that wasn’t intended. Well, one view of the blockchain world is that the blockchain is the ultimate source of truth. Therefore, whatever happened must have been the outcome.
DT:Yeah.
SP:

 

 

27:00

You do have many unintended examples of that and so we’ve seen recent examples of where there was a problem with the code of a new release of a protocol and that resulted in an unintended outcome that then needed to be a governance vote of the DAO to reverse that or effectively to fork the chain and to remedy that outcome. So, the interesting thing about the smart contract is it tells you what to do when things are going right, but when things go wrong, it doesn’t necessarily have the answers and that’s where the legal system, I think, comes in again, in terms of thinking about these traditional notions of mistake and whether or not those concepts still have validity in a of smart contract based world and I think that intersection between the digital and the legal system is still very much playing out and up for debate.
DT:Yeah, absolutely because a smart contract as an artifact of software engineering or computer science is relentlessly logical and relentlessly literal in its application, whereas we enjoy these kind of abstractions in law where we can use reasonableness or, as you say, equitable doctrines of unilateral or common mistake to remedy what is, on the face of it, a literal or logically permissible result in a contract. We can say, “well, no. We didn’t mean it that way. We ought to interfere to remedy that”. So, it’s an interesting situation in which that machine logic and that human capacity for abstract thought and abstraction are butting heads.
SP: 28:00It is interesting and I suppose one other aspect just to highlight is that we still see, notwithstanding that parties are governing some of their relationships through smart contracts. They’re actually using legal contracts alongside smart contracts as well, particularly in the context of commercial counterparties. The other aspect is from a consumer-user perspective, when you interact with one of these protocols, there’s still, terms of service, privacy policy etc. which provide the legal underpinning for some of those interactions. So, while we say, “oh, the lawyers are all going to be out of a job,” there’s still many different aspects of this that give rise to legal issues and even new questions that need to be thought out and I think for lawyers, that’s one of the really exciting aspects of blockchain technologies is needing to reformulate some of our thinking around new use cases, new technology, new ways of doing business and how we can help clients navigate those issues.
DT:

29:00

Yeah and that dichotomy that you identified Steven, I think is a great point about the future of smart contracts and where as lawyers, we see our role. To borrow some of the terminology from the software engineering world, smart contracts are great for the happy path, as you said, for everything is going right and they’re an enabler of automatic execution and performance of contracts but the sad path, there’s still a role for lawyers, for the traditional legal contract sitting alongside the smart contract to resolve some of those ambiguities and unintended consequences, as you say. Now, the last concept I want to cover with you before we talk about some of the current regulatory state, both here in Australia and abroad, is the idea of DeFi. We’ve mentioned the term a couple of times in the interview and it kind of brings together quite a few of the concepts that we’ve just been describing actually. So, DeFi – decentralised finance – what is it and why are you seeing in your own practice so much?
SP:

 

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Sure. To boil it down, in its most simplest terms, I think DeFi is basically software applications that execute on a blockchain. So, what that allows is for traditional financial services, in a sense, to take place on a decentralised basis through blockchain technology and so an example is one of the ones that I mentioned earlier is Uniswap, which is what we call a decentralised exchange or DEX and so some of your listeners might well be familiar with some of the traditional cryptocurrency or centralised cryptocurrency exchanges. So, take for example Coinbase is a big one, BTC Markets, Independent Reserve, Swyftx, for example. These are, what we call, centralised exchanges. So, there’s a company and an intermediary that stands behind that is running an order book where we actually don’t have necessarily a single central intermediary that’s running that. It’s a software application on the blockchain that’s matching orders and it’s something called an Automated Market Maker, for example, an AMM, which is something that will allow users to interact through the blockchain, through a software application, to perform certain transactions. And we’re seeing different uses, different applications of that. It can be in terms of exchange of value but it could also be things like lending or insurance or many other applications and I think what’s potentially very powerful about that is that you have the ability to interact programmatically such that, say for example, one could potentially enter into an insurance policy that pays out depending on a specific event that’s programmed into the blockchain. For example, “if the weather is over 40 degrees, X will pay out because this event will not happen”, that type of thing. So, building those real world links is difficult, I think, and there are some issues around that, but one can see how you start to build these sorts of things in and make them automatic and the idea, think about the insurance industry for example, where submitting a claim is such a time consuming process and then trying to get a payout, often takes, weeks or months or even longer. The promise of blockchain technologies is it can make that turnaround much quicker. The difficulty is around tying things that happen in the real world to the blockchain and that’s where I think we’ll see many more technological innovations around things like oracles, which will allow that to happen.
DT: 32:00Yes. That challenge of tying the digital event to a real world event is an interesting one and you raise the weather. I think that’s because we’ve probably got fairly good sources of digital data about the weather and fairly good APIs for accessing that information and there’s probably a fair bit of work to do both for developers and probably for lawyers as well in finding ways to find that information and reliably tie it to the performance of a smart contract but it sounds like DeFi is really a use case or an example of a lot of the technologies and concepts we’ve just described. They’re smart contracts in the finance and financial services space that might involve transacting on a blockchain on a distributed ledger to say transfer ownership of an NFT.
SP:Exactly. Yeah, no that’s correct. So, it’s that decentralised ability to interact between two or more people to transfer value to interact and perform a transaction.
DT:

33:00

Without those centralised exchanges or centralised authorities. Now, let’s talk about the current regulatory landscape because it’s probably fair to say that laws and regulation probably haven’t quite kept pace with the, frankly, very rapid pace of innovation in the blockchain and cryptocurrency space. What is the latest update on regulation for the blockchain and cryptocurrency industry in Australia?
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So, at the moment in Australia, we don’t have any specifically targeted legislation which deals with the issuance or dealings in digital assets but they are still potentially covered by a range of our existing laws. So, if you take, for example, the question of whether or not any digital asset is a financial product. Now, that’s something that still needs to be assessed on a case by case basis as to whether or not a particular digital asset has the features of a financial product, whether that’s a security, a derivative, a non-cash payment facility, or a managed investment scheme or even just a form of financial investment. At the moment, what we have is some guidance from ASIC in Information Sheet 225, which is intended to give those who are dealing with digital assets, the thumb guidance as to whether or not they might have the indicia of a financial product, but we don’t have any sort of conclusive guidance from a court or any law from the legislature which does definitively define, what is and what isn’t a financial product in the digital asset space. So, at least from an ASIC perspective, it’s really up to the entrepreneur and the business to take legal advice to determine whether or not the digital asset that they’re dealing with is within the regulatory perimeter. If it is, and it is a financial product then there are a range of existing financial services laws which apply and we’re thinking, there, things like the Corporations Act and the ASIC Act. Also, anti-money laundering laws which I can touch on in a moment as well but if it isn’t, and it’s not a financial product, there are still existing laws which apply and it’s important to bear in mind the Australian Consumer Law, for example, which applies to all sales of goods and services and the usual prohibitions around things like unconscionable conduct or misleading and deceptive conduct can still apply to dealings in digital assets which are not financial products.

TIP: In 2014, ASIC made a submission to the Senate enquiry on digital currencies that digital currencies “do not fit within the legal definitions of ‘financial product’ in the Corporations Act or the ASIC Act”.

Following the increase in availability of cryptocurrencies and non-fungible tokens and the wide variety of purposes for which they are used, ASIC revisited this statement in Information Sheet 225, as Steven said. There is currently no definitive guidance from an Australian court or regulator on whether one or other cryptocurrencies is a financial product. The latest version of INFO225 encourages token issuers and promoters to take professional advice on whether a cryptocurrency is a financial product. It’s certainly an area to keep your eye on.

Just to come back to the AML perspective, I think Australia was relatively early in looking at the AML risks around digital currencies and in 2018 there was a regime introduced to require those who are doing conversion between fiat currency and digital currency, which is very broadly defined, to register and enroll with AUSTRAC and along with that comes all the usual AML obligations in terms of KYC and the usual obligations in terms of making suspicious matter reports to AUSTRAC where there are concerns around particular transactions or activity. That’s kind of the state of play at the moment, if you will, in a very, sort of brief summary but I think that the very interesting part and the part your listeners will probably be very interested to hear about is what’s coming down the pipeline. Now, things in that space have changed quite a lot over the last little while. For those who have been sort of tracking this area, late last year there was a senate inquiry which was led by Senator Andrew Bragg which issued a report in around October that came out with a list of 12 recommendations as to what Australia should do in the digital asset space in terms of developing a regulatory regime. Now, most of it was taken up by the Liberal government while the Liberal government was still in place and there was a plan to move ahead with a licensing regime for what was called crypto-asset secondary service providers, which is basically intermediaries to come back to what we were discussing a little bit earlier in this digital asset space. Now, with the changeover in government, that’s all been sort of thrown up in the air in a little bit but just this week we’ve got some direction from the new Labor government who’ve announced that they’ll shortly be commencing what’s called a token mapping exercise. Now, a token mapping exercise is intended to come back to that question we started with; is the digital asset a financial product or is it something else and what is the full gamut of digital assets which are out there, and what are the different potential risks associated with those? So, that’s a very interesting development. I think, basically the government’s plan is to look at the risk first before deciding how they’re going to formulate the regulatory regime around that and I can certainly see some sense in that, as an approach. I think one of the potential risks around it is that we get caught up in very academic debates about what is a particular token product and is this a financial product or not and I’m sure there’ll be a lot of different views around that and exactly what the regulatory regime should look like but it is a positive development in the sense that we now have a direction that we’re moving towards but one thing that we need to continue to look at is what’s going on in other parts of the world and there are a number of other jurisdictions who are moving ahead really quickly in this area, looking at setting up more comprehensive regimes for digital assets and, for those who think it’s important for Australia to be among the leaders in this space and attracting and retaining good talent, I think it’ll be important for us to watch what’s going on in other parts of the world but also to move quickly to provide a framework both for entrepreneurs and businesses, but also for consumers in Australia to take some of the benefit or unlock some of the benefits of this technology.

DT:

 

39:00

Absolutely. I want to come back to securities and financial product regulation first and then ask you a little bit about the Australian Consumer Law point you’re making because, so far as the treatment of crypto-assets as securities or financial products both in terms of the current regulatory environment and in what’s coming down the pipeline, it may be that after that token mapping exercise we see a kind of bespoke treatment for different kinds of tokens depending on the rights that are attached to them but, as it stands now, what are the risks for a token or a crypto-asset being regarded as a security because it seems to me that a lot of the utility based NFTs that we hear about that give access rights to a community that might have some financial right to receive the profit from a subsequent sale or from a performance of some underlying asset. Those really sound like securities to me.
SP:

 

 

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It’s the vexed question really at the heart of a lot of the space is the extent to which tokens mirror traditional financial products. I think one of the things we see is that many of the tokens out there don’t look really particularly like a security. So, in a sense, there’s no claim to any underlying assets. There’s no claim to a profit or revenue stream. There’s certain use or utility governance type rights that attach to that but they’re not familiar as a share in the sense that we would usually understand that. One of the key areas of debate is also around managed investment schemes and whether or not tokens sort of fit that model but as we’ve seen recently, the courts have been grappling with that issue in other contexts as well in terms of litigation funding and whether or not a litigation funding scheme is a managed investment scheme and that the recent guidance from the Full Federal Court was that it isn’t. So, I think these are really vexed questions which apply to tokens, but other types of schemes or products as well and I think this is the real area where founders and businesses are looking for more regulatory clarity because I think once we have that clarity around what is in scope as a financial product? What is not? How are we going to treat NFTs? Is an art the same as a financial product? Once we have that clarity, it’ll actually encourage people to be able to move into these markets and issue new products and services and so I think it’s really vital that we move forward on those sorts of debates relatively quickly because others in the world are looking at these same issues as well.
DT: 41:00

 

 

 

 

 

 

 

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Yeah, that’s such a great point, Steven, that you make about the need for regulatory clarity. I think there might be an attitude among some in the sector that regulators should just leave blockchain and cryptocurrency alone but the reality is, and manage investment schemes is a great example of this, that the law can apply by default unless some greater clarity is given to ensure that doesn’t, and that litigation funding example, litigation funders have enjoyed some specific exceptions from financial product and financial services regulation in the Corporations Act for a long time. Obviously that Federal Court decision was helpful to litigation funders as well but that definition of a managed investment scheme – pooled value for a common purpose – is very broad and I could imagine that capturing a lot of DAOs and a lot of other sort of NFT communities. So, it is a great point that you make, that really, regulators need to step in, need to keep up to liberalise the space potentially, to make sure that laws which are designed for other purposes aren’t hampering innovation or hampering the application of this technology in new use cases unintentionally. I also wanted to ask you about the Australian Consumer Law and misleading and deceptive conduct. What kind of issues are you seeing in the space around the Australian Consumer Law? I mean, one that comes to mind for me as we see a lot of new NFTs hitting the market, promises are often made about future utility associated with the NFT that, “well, these might be used in a film project later, or these might be used in a gaming project later, or these might later form the basis for a social club.” What’s some of the exposure in that particular example and what other ACL issues are you seeing?
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I think we’re still at a relatively early stage. So one of the key issues that we’re seeing in the space is obviously around promotions of particular digital assets or even in the centralised world, exchanges and other things but also in terms of particular projects like NFT projects, for example. Now, I think one of the strong points of the Australian regulatory environment is that we do have good consumer laws. So, even if things don’t fall into the financial product space, there are some sort of basic precepts there around things like misleading and deceptive conduct or unconscionable conduct that do provide some guide rails, if you like, around the issuance of digital assets in this space but in terms of actual disputes around all of that, I think we’re still at a relatively early stage. We’re not seeing too much at this point. At the moment, it’s been more in the case of potential scams which have been an issue and sort of bad actors in the space but in terms of consumer law issues, it’s still, I think, relatively early days but I do expect that to be an area in future particularly, given what’s happened in the markets over the last six months, when asset prices start to go down, people start to think about, “well, hang on, you promised me X and I got Y, and that wasn’t quite what I anticipated.” So, I wouldn’t be surprised if in the next six months or so we start to see more activity in those sorts of areas.
DT:

 

44:00

Yeah, absolutely. There’s nothing like some lean times to promote litigation. Now, I suspect I know what both of our answers to this question are going to be, but I’ll ask it anyway. Marco Iansiti and Karim Lakhani wrote in an article in the Harvard Business Review in 2017, that [i]ntermediaries like lawyers, brokers, and bankers might no longer be necessary… This is the immense potential of blockchain. Now, not our listeners who are lawyers, but I’m sure a lot of people dream of eliminating intermediaries like lawyers, brokers and bankers and do see that as immense potential. Do you think that blockchain can really change the interaction between commercial parties to the point that lawyers are no longer required or do you think we’re always going to have a role in there somewhere?
SP:

 

 

 

45:00

Well, for my part, I think lawyers will still be in the picture there somewhere. I think blockchain technology, like many other technologies before it, just unlocks a whole bunch of new questions and challenges and lawyers really exist, I think, to help our clients kind of navigate those challenges and as we were discussing a little bit earlier in our conversation, thinking through what happens when things go wrong or even on the front end thinking about how some of these projects are programmed and put together. I think that legal brain is still very helpful and can provide a lot of value to projects as they’re thinking through these sorts of issues. As we were talking about earlier as well, you still have all the sorts of terms of use and other things that underpin a lot of decentralised technology that will need input from lawyers. So, I think, what’s exciting, at least from a lawyer’s perspective, is that this new technology will enable lawyers, I think, to work more closely with business people and developers in this space. There’ll be the opportunity to wrap our heads around technology, perhaps in a way that lawyers have been, somewhat slow to do so in the past and as we’re seeing in many other industries, I think that symbiotic relationship between what you do as your core technical skill and technology just becomes closer as those systems get better and better. So, look, I’m biased, but I think, for my part, it’s a fascinating area to be in and I think there’s a lot of opportunity for lawyers to really add value in the space.
DT:

 

46:00

Yeah, absolutely and I won’t surprise anyone to find that I say I agree with you. I think there’s similar conversations about the application of artificial intelligence, of automation technologies that, “oh, this is going to mean the end of lawyers participating in this space or there’ll be, no jobs for lawyers anymore.”‘ Of course, the things that excite us, as professionals, are the volatile, uncertain, bespoke, unique sorts of cases and any technology, whether that’s artificial intelligence, automation or blockchain, that can get us away from the pedestrian and more involved in the bespoke and the unique I would say we’d all welcome as professionals. Now, if there are any lawyers listening to this episode who are persuaded that they want to get into this space, that they think it might be a growth area for their practice or they’re just interested in the technology and wanna learn more about it, what would your tip be to them to learn a bit more about blockchain and maybe try and break into it as a practitioner?
SP:

 

 

 

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Maybe I’ll just sort of talk about my own experience in the sense of how I have gone into it and increasingly gone down the rabbit hole as they say, but look, I think the best thing to do is probably just to play around with the technology a little bit as a starting point and get a sense of how it all kind of works together. This is not financial advice, but get a MetaMask account and buy a little bit of crypto and just see how all of this sort of stuff works. That’s one good way to do it. I’m interested in this stuff from an academic perspective, but also just my intellectual curiosity. I spend a lot of time reading up on developments around the world and one of the really interesting aspects of being this space and that really keeps you on your toes is that every week there’s some new development from a regulatory perspective in the crypto sphere that there’s really intense debate around, around whether or not it should be this way or it should be that way and how technology should respond to that. I think one of the great things about blockchain is that those sorts of debates are really playing out in public. They’re not, kind of, esoteric academic debates necessarily that are had in academic institutions, although they’re happening there as well. They’re happening on Twitter, they’re on podcasts, they’re in blockchain news outlets and publications and this information is very accessible to anyone who’s interested and wants to go down that rabbit hole, if you will.
DT:It’s a fascinating area to be in if you’re the kind of lawyer who’s interested in what the law should be and not just what it is, which, I think we all should be. Now, we’re just about out of time but before we go I’ll ask you one final question. It’ll be great to break it here on Hearsay the Legal Podcast, so hopefully you’ve got a good answer for me. Who is Satoshi Nakimoto?
SP:Well, look, that’s the billion dollar question. I think if I had the answer to that, I might not be on this podcast, but…
DT: 48:00I’m hurt!
SP:But yeah, look, some have speculated it’s one person or maybe it’s multiple people. I think there’s a few personalities who’ve been put forward. Some who claim to be with varying degrees of, kind of, credibility. For my part, I have absolutely no idea. Whoever it is has done an amazing job keeping their identity anonymous for, what, 14 years now and is obviously a hardcore hodler, as they say in the crypto space. Apparently, Satoshi hasn’t spent any of the bitcoin that he mined from the early days. So…
DT:Really?
SP:They are sitting on quite a substantial amount of Bitcoin.
DT:Wow. Well, that’s all we’ve got time for today but Steven Pettigrove, thanks so much for joining me on Hearsay the Legal Podcast.
SP:Thanks very much, David.
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As always, you’ve been listening to Hearsay the Legal Podcast. I’d like to thank our guest today, Steven Pettigrove, for coming on the show.

Now, in today’s episode we talked a lot about cryptocurrency and the blockchain. If you want to hear more about how government bodies such as the Australian Taxation Office are already trying to tackle new blockchain problems, then check out episode 60 with Andrew Davidson. That’s a really great interview with Andrew that focuses on the ways the ATO is trying to keep up with this new age.

If you’re an Australian legal practitioner, you can claim one Continuing Professional Development point for listening to this episode. Whether an activity entitles you to claim a CPD unit is, as you know, self assessed, but we suggest this episode entitles you to claim a substantive law point. More information on claiming and tracking your points on Hearsay can be found on our website.

Hearsay the Legal Podcast is brought to you by Lext Australia, a legal innovation company that’s out to change how you experience the law and legal services, and that includes CPD. I’d like to ask you a favour. If you like Hearsay the Legal Podcast, please leave us a Google review. It helps other listeners find us and that keeps us producing the podcast you love. Thanks for listening.