The United Nations Commission on International Trade Law (UNCITRAL) has prepared a draft guidance document addressing the legal issues surrounding the use of distributed ledger technology (DLT) in international trade. This document, developed through several sessions of UNCITRAL, aims to provide commercial operators with a comprehensive overview of the legal considerations when implementing DLT in their operations, whether for service delivery or internal processes.
Understanding DLT and its Legal Implications
DLT encompasses a wide array of technological systems enabling decentralized recording, sharing, and synchronization of data across multiple participants, with blockchain being its most prominent form. At its core, DLT is a data storage technology that can record information in data messages or support specific applications leveraging its technical features. DLT systems vary in design, governance, purpose, and use, and are often associated with smart contracts, tokens (including NFTs), and cryptocurrencies.
Key characteristics of distributed ledgers include:
- Integrity, ensured by cryptographic techniques that rely on system trust rather than a central entity.
- Pseudonymity, where users are often identified with pseudonyms.
Distributed ledgers are broadly classified as public or private, and permissioned or permissionless.
- Public ledgers allow unhindered access to stored information and are decentralized.
- Private ledgers restrict access to a select group of pre-identified participants.
- Permissionless ledgers do not require user identification for participation.
- Permissioned ledgers require users to identify themselves before gaining access.
Public permissionless ledgers are the most open and decentralized, offering open access, open source code, and transparency. Conversely, private permissioned ledgers restrict users, often have closed source code, operate in controlled environments, offer enhanced privacy, and facilitate faster transaction speeds. Hybrid models, such as public permissioned and private permissionless ledgers, are also possible and often favored by commercial services. Examples of public permissioned ledgers include the European Blockchain Services Infrastructure (EBSI), Lacchain in Latin America, and China’s Blockchain-based Service Network (BSN).
Distinctive features of DLT that have legal relevance include:
- Persistence of Information (Immutability): Data recorded on a blockchain is relatively persistent due to the difficulty of unilateral modification. This feature can have significant legal consequences, for instance, in providing reliable assurance for timestamping functions in security rights registries.
- Interoperability: While distributed ledgers are generally not designed to interact with other ledgers or non-DLT applications, integration of technical standards can improve interoperability and facilitate data flows.
Key Legal Issues for Commercial Operators
The guidance document highlights several legal issues for commercial operators considering DLT:
- Choosing a DLT System: Commercial operators must decide between developing in-house DLT systems or outsourcing to third-party developers, a choice influenced by the scale of operations. Environmental concerns related to DLT mining, particularly the energy consumption of proof-of-work mechanisms, are also a growing consideration, with a shift towards more energy-efficient methods like proof-of-stake.
- Counterparty Vetting: Due diligence on DLT providers is crucial to reduce counterparty risks, ensuring contracts are with legally recognized entities and verifying their track record. Compliance with regulatory standards further enhances confidence.
- Business Continuity Management (BCM) and Service Standards: Commercial operators need to adapt existing BCM plans to DLT’s features and ensure adequate service level management. When procuring DLT systems, verifying the provider’s BCM plans and minimum service levels, through due diligence and clear contractual terms, is essential.
- Audit Procedures and Right to Audit: Independent third-party audits of DLT code, developers, and operators bolster confidence by detecting vulnerabilities and ensuring integrity. Commercial operators should consider contractual clauses granting the right to audit the code.
- Contractual Terms: Terms of use of DLT service providers are vital in defining rights and obligations. Commercial operators should include specific clauses on liability, intellectual property rights, and conflict resolution, where negotiable.
- Managing a DLT System (Malfunctions and Governance): DLT systems can malfunction due to bugs or vulnerabilities. Governance of DLT involves how data is stored and maintained via consensus mechanisms and how services are delivered using governance tools like tokens and Decentralized Autonomous Organizations (DAOs).
- Legal Issues Arising from DLT Use:
- Contract Automation: DLT can enhance confidence in automated contract execution due to information persistence, but complexities like force majeure clauses may not be easily transposed into code. Laws may also require “kill switch” software to prevent undesirable automated executions.
- Liability for Incorrect Information: Due to data persistence, it is crucial to ensure data accuracy on the ledger. Liability for incorrect or fraudulent information typically lies with the person providing it.
- Data Privacy and Protection: Many jurisdictions, like the EU with GDPR, apply data privacy laws to DLT-based applications, raising questions about personal data handling and accountability in decentralized systems.
- Identification and Pseudonymity: While pseudonymity is common in DLT, it can hinder identification when laws require specific verification methods or compliance with regulations like AML and KYC. Technical solutions for selective disclosure can help.
- Digital Assets: The legal treatment of digital assets is evolving. Definitions often focus on control and transferability or the rights they incorporate. Laws are being drafted to define the issuance and transfer of digital assets and their subjection to proprietary rights.
Application of UNCITRAL Electronic Commerce Texts
UNCITRAL texts on electronic commerce significantly contribute to the legal predictability of DLT use in trade, particularly concerning commercial operator-client interactions.
- Technology Neutrality: A cornerstone principle ensuring legal provisions are neutral regarding technologies used, allowing UNCITRAL texts to accommodate DLT.
- Legal Recognition and Effect: UNCITRAL provisions grant general legal recognition to electronic means, including DLT, facilitating cross-border recognition of electronic communications and documents.
- Functional Equivalence: This principle allows paper-based form requirements to be met using electronic means, provided reliable methods are used. DLT features like information persistence and assurance of singularity can aid in satisfying these requirements.
- Use of DLT in Electronic Contracting: The UNCITRAL Model Law on Automated Contracting (MLAC) applies to DLT-based automation, providing legal certainty for automated contracts and addressing issues like legal recognition and attribution of automated actions.
This guidance document aims to equip commercial operators with the necessary insights to navigate the evolving legal landscape of distributed ledger technology in trade, promoting innovation while ensuring accountability and risk mitigation.
Summary by DigitalTrade4.EU