Archive for the ‘ entrepreneur ’ Category

ICO Governance

#Blockchain #Ethereum #Meetup in August: Here is the youtube video of my presentation on #ICO #Governance with Vlad Andrei (HighTechBlock.com): ICO Governance Presentation

ICO Governance Presentation -

@ Fintank Blockchain Meetup Chicago 8.24.2017 – Wulf Kaal and Vlad Andrei (HighTechBlock.com)

 

 

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Blockchain Innovation for Private Investment Funds

 

Abstract

Blockchain technology innovation is proliferating in the private investment fund industry. Using a hand-selected dataset of private investment fund advisers that utilize blockchain technology in various functions (N=120), this article shows that the private fund advisers who utilize blockchain technology are able to generate significant benefits for their clients. The data analysis suggests that blockchain technology plays a primary role in front office and investment functions, in the securing of crypto assets, but also in private investment fund managers’ attempts to satisfy the growth expectations of clients. The findings are consistent with anecdotal evidence suggesting that the returns attainable through crypto investments have no short-term match in legacy systems. Although the use of blockchain technology in private investment fund strategies is still in its infancy, as it evolves and accelerates, the associated innovation benefits promise lasting change for the industry.

 

Keywords: Blockchain, Distributed Ledger Technology, Artificial Intelligence, Machine Learning, Data Science, Data Scientists, Meta Models, Innovation, Entrepreneur, Startup, Big Data, Private Investment Funds, Hedge Funds, Private Equity, Diversification, Compliance, Optimization, Efficiency

JEL Classification: K20, K23, K32, L43, L5, O31, O32

Suggested Citation

Kaal , Wulf A., Blockchain Innovation for Private Investment Funds (July 6, 2017). Available at SSRN: https://ssrn.com/abstract=2998033

Blockchain Innovation for the Hedge Fund Industry

Full paper with data analysis available here.


Abstract

Blockchain technology innovation is proliferating in the hedge fund industry. Blockchain technology plays a primary role in front office and investment functions, in the securing of crypto assets, but also in private investment fund managers’ attempts to satisfy the growth expectations of clients. Although the use of blockchain technology in private investment fund strategies is still in its infancy, as it evolves and accelerates, the associated innovation benefits promise lasting change for the industry.

Introduction

Hedge fund managers have started to embrace the use of blockchain technology to facilitate investment and process optimization. Several private investment funds have spearheaded the implementation of blockchain technology and smart contracting in their business model and continue to expand it. While some funds simply focus on trading bitcoin and other cryptocurrencies to avoid market fluctuations, others invest in and/or acquire companies that use blockchain technology to provide synergies to their other portfolio companies. Yet others go much further by fully automating a hedge fund secured by blockchain technology. This is accomplished by improving the administrative procedures of private equity deal making, or using cryptocurrencies as incentives for data scientists’ competitive models that facilitate investment analysis efficiencies. Examples include private investment funds such as Polychain Capital, the Northern Trust in cooperation with IBM, Numerai, LendingRobot, and Intellisys Capital LLC, Vega Fund, and Melonport, among many others.

Hedge fund advisers use the technology in front office and investment functions, in the securing of crypto assets, but also with regards to the growth expectation of clients. While the overall proportion of strategies of private investment funds that apply modern technologies, including blockchain technology, is still small, as the use of blockchain technology grows in the private investment fund industry, the innovation benefits for private investment funds and their clients promise to result in lasting change for the industry.

Private Investment Funds’ Use of Blockchain Technology

A recent trend in the private investment fund industry pertains to the increasing use of blockchain technology to facilitate investment and process optimization. Several private investment funds have spearheaded the implementation of blockchain technology and smart contracting in their business model. While some funds simply focus on trading bitcoin and other cryptocurrencies to avoid market fluctuations, others invest in and/or acquire companies that use blockchain technology to provide synergies to their other portfolio companies. Yet others go much further by fully automating a hedge fund secured by blockchain technology, using blockchain technology to improve administrative procedures of private equity deal making, or using cryptocurrencies as incentives for data scientists’ competitive models that facilitate investment analysis efficiencies. Examples include private investment funds such as Polychain Capital, the Northern Trust in cooperation with IBM, Numerai, LendingRobot, and Intellisys Capital LLC, Melonport, among many others.

Administrative Process & Compliance Optimization

A significant application of blockchain technology for private investment funds involves the improvement of administrative processes and compliance procedures. For instance, LendingRobot’s LendingRobot Series is a fully automated hedge fund secured by blockchain technology. Unlike other blockchain-based hedge funds that invest specifically in cryptocurrency, such as Global Advisers and Polychain Capital, the LendingRobot Series invests in lending marketplaces— Lending Club, Prosper, Funding Circle, and Lending Home. Its trading is determined by an algorithm based on the investor’s risk preferences. Once the investor has created a trading profile, LendingRobot selects and executes trades that are recorded in the blockchain public ledger on a weekly basis. This facilitates significant efficiencies and facilitates administrative and compliance optimization. Moreover, by recording all transactions in the public blockchain, LendingRobot is able to comply with its best execution obligations as well as locate and audit past trades. The technology helps the firm conduct investigations, but it also facilitates reporting to the SEC.

Most prominently, in February 2017, Northern Trust and IBM entered into a partnership for the commercial use of blockchain in the private fund industry. The partnership provides an enhanced and efficient approach to private equity administration. While the current legal and administrative processes that support private equity are time-consuming, expensive, lack transparency, and involve lengthy, duplicative, and fragmented investment and administrative processes, the partnership’s solution delivers an enhanced and efficient approach to private equity administration by simplifying the complex and labor-intensive transactions in the private equity market. More specifically, unlike the current deal practice in private equity, which requires parties to reconcile multiples copies of the documents that form the deals to understand the greater picture, the blockchain program announced by Northern Trust and IBM allows all involved parties in an equity deal to look at a single compiled version of the transaction and all other data relating to the deal.

Several key benefits are associated with the introduction of blockchain technology in private investment funds’ back-office administrative processes and compliance. By automatically recording all transactions in a given private investment fund along with any documentation or information that is associated with a given transaction, blockchain technology reduces the otherwise significant costs associated with human oversight in recording, organizing, and maintain investment fund data and records. Blockchain technology also creates a verified marketplace and provides market participants with reliable and fully transparent data on market transactions. The technology reduces the need for information exchange among parties because all transactions are fully recorded and transparent. Blockchain increases security because transactions are recorded in an immutable database that ensures the validity of data and removes expensive security procedures and labor-intensive data maintenance while reducing the need for a paper trail. Overall, the technology allows for a significant simplification of transactions and enormous increases in efficiency and speed of private investment fund transactions while providing significant security improvements.

Combining AI, Big Data, and Blockchain

Private investment funds that utilize blockchain technology often combine the benefits offered by the technology with other evolving technologies and cutting-edge applications to create synergies.
Perhaps the most prominent example of a private investment fund that very successfully incorporates the combination of technologies is Numerai. Numerai is a private investment fund with a global equity strategy. Numerai operates on the Ethereum blockchain, utilizing a cryptocurrency called “Numeraire.” Numerai uses artificial intelligence to convert financial data into machine learning problems for data scientists. Using data scientists for investment analysis creates efficiency through a synthesis of data. Data scientists working in this model work to solve the same problems in their own unique ways with different strategies. Numerai synthesizes these models to create a meta-model out of all the predictions from the data scientists. In the Numerai model, the use of artificial intelligence increases efficiency and optimum capital allocation by reducing overhead costs.
Adaptive data analysis is one of the important problems that are being addressed in the Numerai model. When data scientists use the same data set repetitively a risk exists that the training model will overfit the test set of data which can limit the performance of the applied model on a different dataset. To overcome this problem, data scientists working for Numerai are tasked with staking Numeraire on their predictions which in effect represents data scientists’ confidence in their model’s live performance. The staking process, in turn, enables Numerai to choose the optimal model and in the process improve the performance of its hedge fund.

Impact of Blockchain Use on Private Investment Fund Industry

Blockchain technology has the potential to restructure large parts of the private investment fund and banking industry. Most legacy systems at private investment funds and banks are much more expensive than blockchain technologies, are subject to human error, and take much more time. Banks charged $1.7 trillion in processing fees in 2014. Because blockchain technology is transparent, verifiable, self-authenticating, and self-enforcing, financial transactions can be executed instantaneously at near zero transaction costs, increasing the efficiency for business and individuals exponentially. These factors in addition to blockchain technology’s disintermediation through technology driven democratized trust, precipitated the financial industry’s substantial investments into blockchain technologies in fear of becoming obsolete.

Diversification

Diversification is a key element of blockchain-based change in the private investment fund industry. A benefit of investing in digital currencies rather than traditional investments is that digital currencies can be immune to the vicissitudes of traditional stock investments and the equity markets. Although crypto investments can to be just as and more volatile than traditional investments, digital currencies might be used to hedge against traditional investments. Traditionally, investors that were interested in cryptocurrencies and crypto assets had to purchase a single digital asset, like bitcoin, hold it in an application like Coinbase, among others, and often tried to diversify themselves by investing in multiple cryptocurrencies. Several private investment funds, such as TheToken Fund, Polychain, and Logos Fund, provide investors with exposure to a wide range of digital currencies without the risk of investing in either the underlying organization behind a protocol or the digital currency itself. Rather than make one large investment in one cryptocurrency, these funds employ an asymmetric investment strategy by making large-scale investments in numerous cryptocurrencies. The Logos Fund combines such crypto investment diversification with the mining of bitcoins to increase the value of the fund during downswings in the volatile cryptocurrency markets.

Competitive Pressure

The use of blockchain technology increases the competitive pressure in the private investment fund industry. Private investment funds implementing blockchain technology are facilitating and spearheading radical changes in financial markets. First and foremost, the structural characteristic of blockchain as a decentralized model for financial transactions disintermediates and disrupts the existing financial infrastructure. Private investment funds that are first movers in the implementation of the blockchain infrastructure systems in finance directly contribute to that disintermediation and facilitate the accelerating evolution of the blockchain infrastructure in finance.
The competitive pressure in the private investment fund industry increases through operational and business efficiencies gained by those funds that implement the technology. Most large fund advisers in the private equity and hedge fund industry have not yet considered implementing blockchain technology in combination with big data applications and artificial intelligence. This, however, may change in the foreseeable future if and when larger managers realize that their smaller competitors who utilize these technologies gain substantial operational efficiencies and cost savings and are able to substantially diversify their portfolio holdings via such technologies. The threshold for change for bigger managers may be dictated by the implementation cost of such new technologies. If and when the long-term benefits of using the technologies exceed the implementation cost, which are much larger for larger managers than for the smaller managers who are currently experimenting with such technologies, larger managers are incentivized to start the innovation process as well.

Pressure on Fee Structure

The fee structure of private investment funds has changed substantially in the last ten years. Traditionally, the hedge fund industry has charged fees to investors based on the so-called “2/20” formula. This means that most fund advisers were paid monthly or quarterly an annualized 2% management fee based on assets under management and a 20% annual performance or incentive reallocation based on net fund profits. Similarly managers of private equity funds generally used to charge an annualized 2% management fee based on committed capital and most commonly received a 20% commission on returns over a designated amount (referred to as the carry) as incentive compensation. However, the historical fee of 2% of commitments through the reinvestment period, then 2% on the cost basis for the investments/value of fund has shifted in recent years closer to 1.0% for new managers and 1.5-1.8% for established managers with an adequate track record.

It has become increasingly common in recent years for investors to negotiate fees with fund managers, particularly with newer fund managers who may be more willing to engage in such negotiations to induce seed investors at the time of fund formation. Alternative fee arrangements include but are not limited to modified highwater marks, incentive hurdles, and triggers, as well as clawbacks.

Several market factors help explain the pressure on the fee structure of the private investment fund industry. Private fund investors withdrew $70.1 billion from the private investment fund industry in 2016. In 2016 a total of 1,057 private investment funds closed down, exceeding the 1,023 liquidations of private investment funds in 2009, and falling just shy of the record 1,471 closures in 2008. According to some observers the market is oversaturated which increases pressure on private investment fund managers’ performance and results in compromise fee arrangements, such as paying fees on invested capital only.

Blockchain-enabled platforms for setting up a private investment fund cause significant pressure on the existing fee structure of the private investment fund industry. Platforms such as Melonport or Drago enable competitive gains for their clients through fewer costs and time barriers to setting up and running a private investment fund. While such competitive gains will benefit the majority of private investment fund managers and investors, the lower operating costs enabled by the platform models will especially enable new and future managers to enter the market because the start-up costs and compliance costs can be significantly reduced. By enabling low set-up requirements and low costs of running a portfolio, platform models may be able to create an unprecedented competitive environment for asset management strategies. The cost of running a private fund adviser portfolio on the blockchain equals the core usage fees, modular commissions, and the infrastructure costs to be paid on the Ethereum platform.  The usage fees are determined by the protocol, and the modular fees are set by the module developers and are a fraction of a cent or a fraction of the trade volume for each usage.

Funds Lowering Fees via Blockchain Technology

The increasing use of blockchain technology in combination with artificial intelligence and big data contributes to the market pressure on the fee structure of private investment funds. Anecdotal evidence suggests that the majority of private fund advisers that use blockchain technology, artificial intelligence, and big data in different aspects of their operations or strategy have a substantially lower fee structure than those who do not use them. Prominent examples of lower fee structures driven by the use of blockchain technology include those of Lending Robot’s Lending Robot Series, and platforms for blockchain-enabled fund management, such as those offered by Melonport or Drago, among others. While the overall proportion of strategies of private investment funds that apply modern technologies, including blockchain technology, is still small, as the use of blockchain technology grows in the private investment fund industry, the pressure on the fee structure is likely to continue to grow.
Investors in LendingRobot’s Lending Robot Series, the fully automated hedge fund secured by blockchain technology, unlike investors in traditional hedge funds, can withdraw funding on a weekly basis at no additional cost to the investor. Because LendingRobots’ business model removes the investment adviser, overhead costs, and legal fees associated with each investor agreement, LendingRobot is able to charge a mere 1% management fee and a maximum 0.59% fund expense fee per year. Other factors that help keep the fee low include the increased transparency that allows LendingRobot to expense fewer resources on auditing the fund. LendingRobot claims an average performance of from 6.86% to 9.66% depending on the investment strategy selected by the clients. As of March 2017 an analysis of a broad range of traditional hedge funds shows an average of 8.89% annualized return. The increased transparency, reduced costs, and competitive performance enabled by LendingRobot’s use of blockchain technology may give it a competitive advantage in the private fund industry that could continue to exert pressure on fees charged by competitor funds.
The Logos Fund is an alternative investment fund that invests in blockchain and cryptocurrency-related investments. It aims to make blockchain-based currencies accessible to professionals and a broad range of investors by investing in the mining of blockchain-based cryptocurrencies as well as into such currencies directly. To cover base costs and administration, the Logos Fund charges an administrative fee of between 1.2% and 1.92% depending on the size of the investment. The fund management also charges a performance-related fee of from 9% to 21% plus investment surcharges and redemption surcharges in accordance with market practices.

Per-Transaction Fees

Blockchain technology enables managers to charge per-transaction fees which undermines the existing 2/20 fee model. Blockchain technology facilitates a seamless and efficient calculation of management fees per transaction. In contrast to the traditional settlement and calculation of fees in a per-transaction model that created a prohibitive amount of work making such operations very difficult to execute, blockchain technology overcomes all of these restrictions. It enables the fully automated allocation of the appropriate fee to the correct executed trade and associated client account without any manual reconciliation or settlement. While normally the use of this type of fee is prone to human errors that occur during manual calculation or settlement, these errors are removed through the use of blockchain technology which performs the required calculations and settlement procedures automatically and seamlessly. The blockchain enabled per-transaction fee can be pre-determined or modified by the manager in cooperation with clients. It also can be publicly available which allows the private fund adviser to determine the applicable fee in a competitive market. Accordingly, clients who invest in a more transaction-prone strategy will be able to agree upfront to higher fees whereas clients who invest in a less transaction-rich strategy will pay overall lower fees.
While not all blockchain-enabled private investment funds charge per-transaction fees, the majority of private fund advisers that use blockchain technology, artificial intelligence, and big data in different aspects of their operations or strategy charge their investors lower fees. Prominent examples of lower fee structures driven by the use of blockchain technology include those of LendingRobot’s LendingRobot Series, the Logos Fund, and platforms for blockchain-enabled fund management, such as those offered by Melonport or Drago, among many others.

Conclusion

The rise of blockchain technology and the prominent applications of blockchain technology serve as prominent examples of the impending seismic shifts in the private investment fund industry. The paper has illustrated that the rise of blockchain applications in private investment funds already has an impact on the industry’s front office and investment functions, in the securing of crypto assets, but also in private investment fund managers’ attempts to satisfy the growth expectation of clients. As the industry continues to evolve in the blockchain realm, more change is inevitable. Legacy infrastructure upgrades via blockchain technology may only be a first step towards crypto integration and evolution via the private investment fund industry. Regulatory guidance will be essential to ensuring the continuing evolution and blockchain integration for the private investment fund industry.

 

Crypto Transaction Dispute Resolution (54 Pages)

 By Wulf A. Kaal & Craig Calcaterra
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Prof. Wulf A. Kaal, Ph.D.

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Prof. Craig Calcaterra, Ph.D. 

 
Abstract
The rapid evolution of anonymous, autonomous, and distributed blockchain-based smart contracting creates friction and enforceability issues with existing legal and jurisdictional principles, calling the future governance of blockchain technology into question. The effective governance of blockchain technology and smart contracting is essential to ensuring its continuing evolution. Based on the mathematical principles underlying the disposition of blockchains, we propose and evaluate an alternative approach to the existing legal exercise of jurisdiction that is inherent in blockchain technology itself. We call this distributed jurisdiction.
 
This contribution is not merely theoretical. Several Ethereum smart contracting crypto startups demonstrate that anonymity can be perpetuated in blockchain technology, despite blockchains’ eternal storage of information and its growing size working against anonymity. Startup applications highlight that the technology itself offers means of internal controls that help ensure effective governance in the continuing evolution of the technology.
 
Based on the concept of distributed jurisdiction, we suggest an open source platform ecosystem for smart contracting dispute resolution that allows users to opt into a conflict resolution mechanism that enables more nuanced crypto solutions and produces greater certainty in the process. Anonymized arbiter expertise via rankings in combination with a representation option for crypto disputes provide a resolution mechanism for legacy businesses that desire to participate in the growth of crypto business opportunities, hope to avoid legacy system intermediation and the associated transaction costs, but require legal legacy system assurances and crypto dispute resolution equivalence.
 
Keywords: Blockchain, Distributed Ledger Technology, Artificial Intelligence, Innovation, Entrepreneur, Start-up, Big Data, Smart Contract, Jurisdiction, Governance, Ties Network, Aragon, OpenBazaar, Ethereum, Platform, Ecosystem, Dispute Resolution, Arbitration
 
JEL Classification: K20, K23, K32, L43, L5, O31, O32
 
Suggested Citation:
 
Kaal , Wulf A. and Calcaterra, Craig, Crypto Transaction Dispute Resolution (June 26, 2017). Available at SSRN:

Smart Contract Dispute Resolution – The Need for an Open Source Blockchain Platform Ecosystem

by Wulf A. Kaal & Craig Calcaterra

Abstract

An open source platform ecosystem for dispute resolution of crypto transactions allows users to opt into a conflict resolution mechanism that enables more nuanced crypto solutions and produces greater certainty for legacy businesses than existing solutions such as the Aragon network or OpenBazaar. The ecosystem provides anonymized arbiter expertise via rankings in combination with a representation option for crypto disputes. It provides an effective resolution mechanism for legacy businesses that desire to participate in the growth of crypto business opportunities, hope to avoid legacy system intermediation and the associated transaction costs, but require legal legacy system assurances and crypto dispute resolution equivalence.

Introduction

Any existing business logic can be coded into a blockchain. Blockchain technology is a computer architecture for an open and secure distributed database. A blockchain, in essence, is an autonomous dynamically growing chain of blocks of encrypted data generated by a decentralized group of users. Most blockchains, such as Ethereum (but not Bitcoin) are Turing complete, or computationally universal, meaning any calculation possible can be simulated within a blockchain design. In other words, blockchain can do what any other computer program can do–from controlling a Mars lander to moderating online competitive video games between Europe and China. Accordingly, any existing business logic can be coded into the blockchain, giving it extremely wide applicability in almost all industries and subject areas.

Because of its very expansive and near universal applicability, it is crucial for the broadening evolution of blockchain technology to find jurisdictional means for the governance of the crypto economy that is facilitated and sustained by blockchain technology. A lack of governance and conflict resolution mechanisms would undermine the democratized trust created by blockchain technology and hinder its broadening evolution and applicability. Jurisdictional means are the basis for effective conflict resolution mechanisms applicable to crypto transactions in the blockchain. Not having the required jurisdictional means necessary for conflict resolution mechanisms for Ethereum blockchain-based smart contracting, may invoke consumer mistrust in the new technology. This can then undermine the evolution of the blockchain-based crypto economy.

Regulatory alternatives for blockchain-based conflict resolution are necessitated by the impossibility of consistently identifying the parties in any dispute in the context of crypto transactions on the blockchain and the associated problems of applying the existing legal infrastructure. We cannot conceptualize opportunities in the crypto transactional universe that could possibly enable and allow a court in the existing legal infrastructure to decide and enforce any disputes between crypto transactional parties. Because of the severity of these challenges for the existing legal and jurisdictional infrastructure, we conclude that the sensible approach for including good governance in crypto transactions necessitates instituting governance solutions inherent in the blockchain technology itself. Accordingly, we introduce the concept of a distributed jurisdiction, which we hereinafter evaluate.

Limited Regulatory Oversight

The regulatory oversight over blockchain-based transactions is severely limited. Courts arguably cannot have jurisdiction over blockchain-based smart contracts because it is unlikely a court could find out who transacted via the anonymized blockchain. Furthermore, the court could not change or otherwise affect the transaction as it was coded because once the coded parameters were fulfilled the transaction auto-executed on the blockchain. Because of automated execution, contractual breach and damages are less likely to occur in smart contracts, especially as compared to traditional contracts.  If a given smart contract transaction disadvantages one of the contracting parties, courts would have to change the blockchain in order to institute remedies in the traditional sense that could pertain to the smart contract in question. However, that scenario is computationally and practically impossible.

Assuming the parties to a given smart contract were known, courts could require the parties to create a new transaction to reverse undesirable outcomes of the coded and executed transaction that was disputed. This is a possible solution because courts are unable to affect the initial outcome of a disputed smart contract transaction. Courts cannot require a retroactive change in the blockchain because that is computationally near impossible. Given that the requirements for a court to exercise jurisdiction over a disputed smart contract are fundamentally different from courts’ jurisdiction over contracts in the existing legal infrastructure, contracting parties would likely second-guess courts’ decisions pertaining to smart contract disputes. In other words, real world court decisions even if attainable may not have the same legitimacy and authority as other intra-blockchain dispute resolution mechanism may have.  In summary, courts would only be able to force the parties to execute a secondary transaction or otherwise pay remedies for a smart contract that created damages for one of the parties. Courts would not be able to actually change or interpret the terms of the given smart contract that was executed according to its parameters and added to the blockchain where it is immutable.

Because of these inherent limitations, courts will generally not be able to effectuate resolutions to disputes arising from blockchain-based smart contracts. Courts do not have the power over the coder and the code that was used by the parties that may have been injured. Courts do not have the authority to dictate to a programmer how, when, and where to change the existing code used by consumers.  Even if courts were given such authority, no programmer so coerced by the court would be able to override the will of the majority of anonymous international blockchain users to make an effective change. Therefore, blockchain-based resolution mechanisms are the only possible recourse for smart contract disputes.

Our proposal for courts to leave dispute resolution to blockchain-based mechanisms is not a mere theoretical postulate. Rather, this need was already introduced in the second and third prongs in Aragon’s whitepaper about blockchain-based solutions for consumers facing code execution problems in smart contracts.

Anonymity of Blockchain Transactions

The lack of identifiable parties in crypto transactions creates a distinct separation between real world and crypto transactions that has lasting implications for the application of existing jurisdictional principles. The aforementioned anonymity gained by the use of public-key encrypted identities and VPNs prevents the identification of the parties to a smart contract.  Without identifiable parties, jurisdictional principles such as subject matter jurisdiction, personal jurisdiction, diversity jurisdiction, and federal question jurisdiction become irrelevant. To illustrate this point, proving personal jurisdiction by means of 1. Physical Presence, 2. Domicile/Place of Business, 3. Consent, and 4. Minimum Contacts becomes impossible as none of these elements are known of the parties in a smart contract. Physical presence is anonymous, as is domicile, consent, and minimum contacts. Subject-matter jurisdiction, e.g. a given court can exercise power over a claim that the laws of the jurisdiction authorize such court to hear, is inapplicable because no given law would be able to authorize such power. But even if a given State or even the Federal Government were to pass a law that would grant such authority to a court, it is hard to see how the court would in fact exercise such authority, short of limiting access to the internet itself.

Not all smart contracts are fully anonymous and untouchable by traditional jurisdictional means. Some smart contracts will not automatically anonymize the parties because there is a physical element to such a consumer contract. For example, a powerful traditional corporation may wish to execute a complicated, non-hostile takeover of another company, using their reputation as leverage. The transparent, public, and perfectly logical structure of a smart contract could theoretically improve communication in such a negotiation. However, many other smart service contracts can be completely anonymous. For instance, a service contract involving services pertaining to cyberspace, such as programming services to create a given webpage, will be completely anonymous. It is important to note that as the technology becomes more widely accepted, such service contracts are going to become a highly important part of any given economy.

Even outside of cyberspace services, it is clearly possible that bounties for anonymous work executed via smart contracts will make traditional service contracts that require personal knowledge and physical appearance redundant. A bounty contract for anonymous work allows an anonymous employer to put a bounty on a given job and offer such a job on an anonymous smart contracting network to an anonymous counterparty. The contract acceptance and performance is dictated to some extent by reputational factors that link the counterparty and the performance under the contract. Part of the value of anonymity in such instances is the clear efficiency advantage. The bureaucracy that attends traditional employment is in this case greatly reduced, if not eliminated.

Enforcement of Smart Contracts

The enforcement of smart contracts with traditional legal means is limited. First, disputing a smart contract with traditional means (in court, arbitration, mediation, etc.) is only marginally possible because of the aforementioned anonymity in blockchain transactions. Moreover, while smart contracts are coded as self-executing contracts, they do not necessarily provide effective mechanisms for enforcement if one party breaches his or her obligations in the smart contract. Semantically, it may be argued that breach of a smart contract is not even possible: the contract simply will not execute if a parameter is not fulfilled.

The literature is split on remedies for breaches of smart contracts. Some argue that because the smart contract replaces the existing legal contract in some circumstances, the smart contract will be governed by the same legal principles as the existing legal contract. Others argue that the breaching party may not live in an area where the courts have jurisdiction, thus the breaching party cannot be liable. In that case, assuming the operator knows the identities of the contracting parties, the operator of the blockchain platform should have a legal obligation to identify who the breaching party was and serve as the counterparty in a dispute scenario.  These experts argue the operator of the blockchain should establish governing rules of the blockchain and specifications for dispute resolution. However, these specifications would have to be disclosed upfront and agreed upon by the parties to the smart contract in order to be enforceable.

Courts may be substantially challenged in interpreting smart contracts. Unlike the interpretation of a contractual dispute in the existing legal infrastructure where courts will assess what the contentious language in a given contract may mean to a reasonable human observer, smart contracts are not coded for a human observer. Rather they are intended for computer programming in a network of nodes (and in the future for artificial intelligence). To the extent that consumers are using smart contracts, the human element may be increased via the coding of graphical user interfaces. The basic premise of smart contracting remains emphasized on computer programming (and in the future artificial intelligence) not human interaction. Because of the emphasis on code for computer programming (and artificial intelligence), courts may not be able to hypothesize a reasonable human’s interpretation of a given smart contract. Courts may also be limited in their ability to consult programmers to interpret the coded language at issue in a given case because the meaning and logical reasoning of coded language is substantially different from human language.

From an evidentiary perspective, it is unclear who would own smart contracting blockchain contributions and whether there would be any applicable protections, such as work product or confidentiality. Without ownership rights for a blockchain transaction, it is also unclear who would be able to claim privileged information or how discovery would operate via existing laws. However, when the parties to a smart contract choose to reveal their identities, arguably privileged information or discovery laws should apply as if it was a written contract despite the fact that the contract was written in code.

Contract law remedies may not apply to smart contracts which raises possible enforceability issues. If a transaction in a smart contract fails to be completed or is partially completed but not added to the blockchain, it is unclear how liability will be allocated if those eventualities have not been accounted for in applicable code. Because of the blockchain’s decentralized nature, it is unclear who or what is accountable and could require regulation. Without solutions for those issues, liability for failed transactions or conflicts between parties have little guidance as to being resolved.

Distributed Jurisdiction

The nature of smart contracting necessitates crypto dispute resolution mechanisms. Problems with smart contracts tend to be two-fold. First, while smart contracts can be coded for and encapsulate a substantial portion of possible breaches of contract, subjectivity in human relationship, bounded rationality of coders and contracting parties, incomplete foresight, incomplete information, and opportunistic behavior will make breaches or other problems in smart contracts inevitable. Second, the first DAO has demonstrated that software and coding bugs will be inevitable in the evolution of the crypto economy. As the existing jurisdictional infrastructure is bound to produce suboptimal results for such crypto disputes, intra-blockchain distributed jurisdictional means are needed.

Our proposal in this paper for a distributed jurisdiction over blockchains has to fulfill two core requirements: 1. The anonymity of blockchain-based smart contracting has to be maintained as the technology evolves. Without anonymity of blockchain-based smart contracting the existing jurisdictional means (in personam jurisdiction) can apply to smart contracting which would undermine the evolution of the crypto economy and make distributed jurisdictional means unnecessary. 2. Distributed jurisdictional means necessitate governance from within the blockchain technology itself to effectively address the problems inherent in blockchain-based smart contracts. Without internal blockchain-based governance, a fully self-sufficient crypto economy may not be possible as legacy systems and governance intermediaries in the existing legal infrastructure will attempt to interfere with crypto transactions, resulting in suboptimal outcomes that cannot be fully resolved in the existing legal infrastructure.

Both requirements for the development of distributed jurisdictional means, full anonymity and intra-blockchain jurisdictional means, can already be accomplished. First, the Ties Network project demonstrates that anonymity can be perpetuated in blockchain technology, despite blockchains’ eternal storage of information and its growing size working against anonymity. Second, the Aragon Network demonstrates that the technology itself offers means of internal controls that help ensure effective governance in the continuing evolution of the technology.

The Need for an Open Source Blockchain Platform Ecosystem for Smart Contract Dispute Resolution

Based on the concept of a distributed jurisdiction, we suggest an open source platform ecosystem of smart contracting dispute resolution that allows users to opt into the conflict resolution mechanisms that enable more nuanced crypto solutions and produce greater (legal) certainty in the process. First, an open source platform based ecosystem for dispute resolution of crypto transactions could help ensure anonymity in blockchain transactions by facilitating anonymity for transaction parties to opt into the platform. Second, the platform would allow users to identify the highest possible expertise of their judges and arbitrators by way of reviewing the record of decisions of their judges across different fora and different types of conflicts. The proposed platform ecosystem would significantly boost consumer confidence in the non-arbitrary and fair resolution of their disputes. Our proposal constitutes an open source ecosystem hybrid that provides effective solutions for the shortcomings in the Aragon and OpenBazaar models.

In contrast with the OpenBazaar solutions, our proposed open source ecosystem allows dispute resolution only if and when a smart contract has resulted in a dispute. This solution ensures that smart contracting transaction costs remain near zero and the cost of paying an arbiter/notary/judge only occurs in cases of smart contract dispute resolution issues which will be a fraction of the overall quantity of smart contracts executed in the evolving crypto economy. As such, our proposal helps stimulate the evolution of the crypto economy. We envision a further improvement in comparison with OpenBazaar’s approach which includes an open review system for evaluating the reputations of arbiters. Arbiters would submit their judgements to the community for review, removing all personal information to ensure anonymity. The community could upvote or downvote such judgments. Arbiters could improve their reputations by submitting comments and counter-judgements for upvotes in an open forum.

This proposal has several benefits that can be distinguished from the Aragon network in several important ways. It involves the same necessarily democratic solution as in the Aragon system, except for several core differences: 1. The cases are not bound to binary decisions (it’s unclear how 5 anonymous judges would collaborate to give a nuanced answer in Aragon). 2. Crowdsourcing the judgments leads to more efficient appeals. 3. Decisions would be open to re-evaluation for all eternity, so the judges’ reputations are subject to a greater ideal than mere contemporary popularity. Further, this approach still promotes the eternal anonymity of parties and arbiters, as judges who revealed private information would be severely downvoted.  Thus, our proposal provides more nuanced and better outcomes with better representation for parties in smart contract dispute resolution.

By way of analogy, just as federal courts in the existing legal infrastructure often provide better outcomes for litigants than state courts, because of the better qualifications of judges and the higher stakes involved, among other factors, our open source ecosystem would allow litigants more choice among dispute resolution mechanisms, enable better representation, and facilitate increased quality of arbiters. For claimants who have an interest in the best possible outcomes and are willing to wait analog times (≈1 month) the platform provides ideal fora to settle disputes.

Legal Equivalence

Stakeholders in legacy systems will likely hesitate transferring their legacy infrastructure businesses, and revenue streams derived therefrom, to an uncertain blockchain infrastructure and crypto systems without significant and sufficiently incentivizing assurances that they are not sacrificing any attained existing legal rights in exchange for smart contract efficiency in a blockchain system. Accordingly, the adjudication, dispute resolution, and enforcement of smart contracting disputes in the evolving crypto economy have to provide equivalent measures that assure legacy businesses that they can operate in crypto systems without a surrender of existing rights.

Legal equivalence can be assured in the implementation and transition phase of the crypto economy via dual integration. Dual integration refers to the use of legacy legal infrastructure in smart contracting dispute resolution, such as via the Ricardian contracts, among other measures, in combination with intra-blockchain systems for the resolution of smart contract disputes.

For participants in the crypto economy who wish to minimize the transaction costs of dual integration and retain anonymity our proposed open platform ecosystem is more likely than all other solutions to provide legal equivalence of dispute resolution mechanisms. Our proposed system would maintain the importance of good education and reputation on the principles of law. Yet, it would still eradicate much of the corrupting collection of power that specialized knowledge and relationships give to analog lawyers.

Anonymous Arbiter Expertise

The platform ecosystem would allow users to identify the highest possible expertise of their anonymous judges and arbitrators by way of reviewing the record of decisions of their judges across different fora and different types of conflicts. We propose using the open and eternal ledger for purposes of listing the following information pertaining to a given decision maker in smart contracting disputes: 1. Contractual Subject Matter, 2. Cases, 3. Decisions, 4. Justifications for Decision, 5. Dicta. Based on such disclosures, we propose an open system that allows comments which could be up-voted or down-voted.

The system allows for the expertise of judges to be determined by anonymous rating systems or anonymous reputational reporting.  In a DAO tokenholders can earn additional tokens by making proposals for the improvement of the DAOs.  If a tokenholder’s proposals was voted in by the DAO community but the tokenholder proponent whose proposal was voted in cannot perform in the implementation of such proposal, such proponent will rarely get a second chance at making and implementing a given optimization proposal. We see our system of anonymous rating for judges as a parallel to the tokenholder voting system for optimization proposals in a DAO. Judges who do not receive sufficient upvotes simply may not get additional chances to work as a judge in a given smart contracting dispute.

To mitigate the inevitable centralization that comes with expert involvement in a decentralized dispute resolution platform and ecosystem we provide several solutions. Because our proposed system is based on upvotes from users who have an interest in the subject, abuse of authority that happens naturally in the non-anonymous world (on mathoverflow among others) would be rather limited if not non-existent. And, crucially important for the success of the system in a legal realm, any abuse of authority would quickly be dis-incentivized by the deluge of downvotes such infamy would bring. Our solution allows anonymous contributors to gain reputation in certain areas of disputes based on whether their opinions are well-received. Such systems already exist in non-dispute resolution contexts. Reputation may also accrue and promote decision makers in dispute resolution by means other than erudition, such as network recognition, connectivity, among others.

Optimized Representation

The open source platform ecosystem of dispute resolution in a distributed jurisdiction also facilitates optimized representation of a given party who in the Aragon system would only informally be able to use lawyers and perhaps would use lawyers from the existing jurisdictional infrastructure. The ecosystem allows for a more diverse allocation mechanism for smart contracts disputes to the most appropriate decision-making body/forum. But also, a platform ecosystem of dispute resolution fora would allow the integration of user representation in a given dispute.

The Aragon network does not facilitate a representation system for dispute resolution. In the Aragon network, a user who wishes to dispute the execution of a contract in the Aragon Network posts a bond and prepares a brief on their argument. Such briefs are not necessarily written by a representative of the user. However, as the stakes get higher in the crypto economy and smart contracting, users may want to seek smart contract representation on their behalf to optimize their chances of success in front of decision makers in their respective disputes. Such representation in the platform ecosystem of decentralized jurisdictions would be enabled. The ecosystem would allow for a matching of representation and dispute resolution fora.

Conclusion

Distributed jurisdictional means for blockchain technology enabled smart contracting provides much needed governance from within the blockchain technology itself. Intra-blockchain distributed jurisdictional means such as via distributed jurisdiction are needed because the existing jurisdictional infrastructure produces suboptimal results for smart contract disputes. Distributed jurisdictional means effectively address the problems inherent in blockchain-based smart contracts. Our proposal in this paper for a distributed jurisdiction over blockchains ensures the maintenance of anonymity of blockchain-based smart contracting as the technology evolves.

Building on the concept of distributed jurisdiction, we propose an open source platform ecosystem for smart contract disputes. Our proposal ensures full anonymity in blockchain transactions by instituting a requirement of anonymity for transaction parties to opt into the platform.  The platform also ensures users can identify the highest possible expertise of their judges and arbiters. Our proposed system maintains the importance of good education and reputation on the principles of an evolving crypto law. Yet, through its anonymization it also eliminates the corrupting collection of power that specialized knowledge and relationships give to analog lawyers.

Implementation of the proposed platform ecosystem for smart contract disputes would significantly boost consumer confidence in crypto transaction through the non-arbitrary, low to no-transaction cost, inducing effective and fair resolution of possible crypto disputes.

For participants in the crypto economy who wish to minimize the transaction costs of dual integration and retain anonymity, our proposed open source platform ecosystem is more likely than all other available solutions to provide legal equivalence of dispute resolution mechanisms. For legacy businesses that desire to participate in the growth of crypto business opportunities, hope to avoid legacy system intermediation and the associated transaction costs, but require legal legacy system assurances and crypto dispute resolution equivalence, our proposed system offers a preferable and indispensable solution. By attracting legacy businesses and instilling confidence in the legal equivalency of dispute resolution in crypto transactions, our proposed solution makes an indispensable contribution to the evolution and significant growth of the crypto economy.

 

The Need for a U.S. Sponsored Blockchain Platform

We have a problem in the United States: What is needed is the government creating a blockchain platform that crypto startups can build on. Think about historically what the government adoption of the Telegraph or the Railway, among other government initiatives, did for the U.S. economy. Without the legal certainty that the technology is supported, its great potential cannot be realized in the United States. We are partially limited because of our excellence in legacy systems. There may also be fears of loss in employment statistics but all this is all rather short sighted.
 
I see daily how clients/advisees are interested in crypto transactions but are holding back because of lacking regulatory guidance. Were the government to embrace the technology by way of a government sponsored blockchain initiative or platform, the US would undoubtedly become a leader in the crypto economy very quickly. It’s time to embrace Blockchain Technology quickly!!!!
 
Russia and Singapore are already embracing Blockchain technology and Ethereum. If Russia implements Blockchain Technology and Ethereum first, it will gain similar advantages to those the Western countries realized at the start of the internet age because Blockchain Technology may have the same effect on businesses that the emergence on the internet once had — it would change business models and create enormous opportunities for growth.
 
Adoption of Ethereum in Russia has already been brisk also in the private sector: last week, Bloomberg reports that Russia’s state development bank VEB agreed to start using Ethereum for some administrative functions. Steelmaker Severstal PJSC tested Ethereum’s blockchain for secure transfer of international credit letters.
 
See evidence of Russia’s ambitions in Blockchain:    http://www.zerohedge.com/news/2017-06-12/putin-meets-ethereum-founder-create-national-virtual-currency

The “Unmediated” and “Tech-driven” Corporate Governance of Today’s Winning Companies

Full article available at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2922176

MARK FENWICK,* WULF A. KAAL,** AND ERIK P.M. VERMEULEN***

Recent corporate governance initiatives encourage a culture of long-term value creation and growth but cannot work as intended by policymakers. The current discussion about corporate governance ignores the transition from a centralized to a decentralized, unmediated, and interconnected world and from a world of vertical hierarchies to a world of horizontal, open, and autonomous networks. This transition process was initiated and is increasingly accelerated by rapid technological change, including developments in social media, blockchain-based smart contracts, decentralized autonomous organizations, big data, and artificial intelligence. This paper shows how policymakers, regulators, business people, consultants, and other corporate governance experts can re-conceptualize corporate governance in a technology-driven and interconnected world.

Keywords: Algorithms, Artificial intelligence, Big data, Blockchain, Board of directors, Communication, Corporate Culture, Corporate Governance, Decentralization, Decentralized autonomous organization, Dialogue, Platform company, Social media, Stewardship codes, Technology, Trust

JEL Classification: C88, D20, D23, F60, G30, K20, K22, L20, L25, L29, O10, O30, O40

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