Archive for the ‘ platforms ’ Category

International Digital Chamber of Commerce (IDCC – Zug Switzerland)

Environmental-Sustainability

Absolutely delighted and honored to become a co-founder of the International Digital Chamber of Commerce (IDCC – Zug Switzerland), a humanitarian organization using blockchain and digital technology for resolving the world’s problems, including the Sustainable Development Goals. More to come on this very soon…!

 

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Blockchain Technology and Race in Corporate America

Wulf A. Kaal

Abstract

Blockchain technology provides anonymous and secure transactional guarantees through democratized trust and disintermediation. Minorities and disenfranchised communities can benefit from the evolving technology and its anti-discrimination features. The article evaluates how blockchain technology helps minimize discriminatory practices in corporate America and creates a more equal society.

Key Words: Blockchain, Distributed Ledger Technology, Artificial Intelligence, Machine Learning, Data Science, Data Scientists, Entrepreneurship, Innovation, Big Data, Efficiency, Race, Community Development, Minorities, Discrimination, Optimization, Equality

I. Introduction

Race is at the core of American democracy yet racial equality in America is elusive. Race has played a large role in American politics and business since the end of slavery. Whereas in the early days of the American democracy the race struggle involved access to property, voting and other fundamental rights, the modern-day race conversation has shifted towards barriers to entry in corporate America.

Inequalities along racial lines in America can be traced in data. Researchers have commonly recognized the disproportionate large number of minorities in unskilled labor who are likely to remain untrained. During the Great Recession, a large number of African American manufacturing jobs were lost, but have steadily been returning. After the Great Recession, African American unemployment rose at a greater rate than Caucasian unemployment and African American unemployment also stayed higher for longer. This data suggests that minorities in America are “first fired, last hired”. While minorities have been able to improve in attaining upper-level corporate positions in the 1980s and 1990s, minorities were still disproportionately affected by layoffs through corporate restructuring in the 1980 and 1990s. In the early 2000, however, the risk for minorities to be laid off because of corporate restructuring decreased.

Discrimination is a common phenomenon in corporate America. Opaque promotion processes in corporations require political positioning with corporate institutions. Using Fortune 1000 corporations as a sample, one study suggests that 76% of the sample dataset had at least one minority member on their board which reflects an increase of 2% from 2003 and a 32% increase from ten years before. Within this minority sub-sect, African Americans account for 47%, Latinos account for 18% and Asians account for 11%. Contrasting these numbers with the ethnic composition of the United States, in the 2010 United States Census, African Americans made up 12.6% of the population, Latinos made up 16.3% of the population and Asians made up 4.8% of the population. Minorities as a whole made up 37.7% of the United States population. This means that of the minorities in the United States, 33.4% are African American, 47.7% are Latino and 12.7% are Asian. The remainder of the minority population identify as some other race.

The data suggest that minority groups are being underrepresented in Corporate America by significant margins without considering external factors. In the sample dataset of Fortune 1000 companies, 37% of employees are women and about 15% are minorities. Management positions are held only at 17% by women and 6% by minorities. Executive level management positions are only at 6% women and 3% minorities.

Based on the available data, this paper examines discriminatory practices afflicting disenfranchised communities in corporate America including its origins in corporate structures, corporate culture, and on the level of the board of directors. After examining such discriminatory influences in corporate America, the paper examines how employing blockchain technology can support a more equal society and help counteract historically grown and path dependent inequalities in corporate America.

II. Blockchain Technology

Leading technologists around the world have hailed blockchain technology as one of the most important technological innovations since the Internet. The peer-to-peer interactions and transactions in a decentralized network where all participants are equal and verification and validation of each transaction is provided by all parties in the network through the blockchain technology provide near unlimited opportunities and applications. For instance, in the financial world, a global consensus record of information and transactions creates the much-needed transparency and, at the same time, opens global access to finance, including in areas of the world where the banking system — in contrast to a mobile telephone network — is not readily available. The technology incentivizes direct transactions, including compensation, between the creator and consumer, eliminating the need for intermediation.

Blockchain technology creates a platform for trust through truth and transparency for parties. Blockchain technology can be described as “an open, distributed ledger that can record transactions between two parties efficiently and in a verifiable and permanent way.” Moreover, blockchain records are incredibly secure, as it is nearly impossible to alter a transaction once it has been added to the blockchain. Because the blockchain (at the least the public blockchain) is in fact public and immutable, the technology increases transparency, while at the same time significantly reducing transaction costs. Intermediaries, including lawyers, are replaced by code, connectivity, crowd, and collaboration.

Blockchain technology has been defined in many different ways, and no truly uniform definition seems to exist. Some refer to it as a giant worldwide, distributed, immutable “google spreadsheet” for transactions. Others define blockchain by focusing on its central elements, e.g., it is a transaction ledger, electronic, decentralized, immutable, and provides cryptographic verification, among several other elements. Vitalik Buterin, the founder of Ethereum, perhaps most prominently defined blockchain as follows:

Public blockchains: a public blockchain is a blockchain that anyone in the world can read, anyone in the world can send transactions to and expect to see them included if they are valid, and anyone in the world can participate in the consensus process – the process for determining what blocks get added to the chain and what the current state is. As a substitute for centralized or quasi-centralized trust, public blockchains are secured by cryptoeconomics – the combination of economic incentives and cryptographic verification using mechanisms such as proof of work or proof of stake, following a general principle that the degree to which someone can have an influence in the consensus process is proportional to the quantity of economic resources that they can bring to bear. These blockchains are generally considered to be “fully decentralized”.

Rather than attempting to agree on a mutually acceptable phraseology for a definition, a description of the core elements of ledger technology can help define the blockchain. As such, a blockchain is a shared digital ledger or database that maintains a continuously growing list of transactions among participating parties regarding digital assets – together described as “blocks.” The linear and chronological order of transactions in a chain will be extended with another transaction link that is added to the block once such additional transaction is validated, verified, and completed. The chain of transactions is distributed to a limitless number of participants, so-called nodes, around the world in a public or private peer-to-peer network.

Blockchain technology removes fraudulent transactions. Compared with existing methods of verifying and validating transactions by third-party intermediaries, blockchain’s security measures make blockchain validation technologies more transparent and less prone to error and corruption. While blockchain’s use of digital signatures helps establish the identity and authenticity of the parties involved in the transaction, it is the completely decentralized network connectivity via the Internet that allows the most protection against fraud. Network connectivity allows multiple copies of the blockchain to be available to all participants across the distributed network. The decentralized, fully-distributed nature of the blockchain makes it practically impossible to reverse, alter, or erase information in the blockchain. Blockchain’s distributed consensus model, e.g., the network “nodes” verify and validate chain transactions before execution of the transactions, makes it extremely rare for a fraudulent transaction to be recorded in the blockchain. That model also allows node verification of transactions without compromising the privacy of the parties and is therefore arguably safer than a traditional model that requires third-party intermediary validation of transactions.

Cryptographic hashes further increase blockchain security. Cryptographic hashes are complex algorithms that use the details of all previous transactions in the existing blockchain before adding the next block to generate a unique hash value. That hash value ensures the authenticity of each transaction before it is added to the block. The smallest change to the blockchain, even a single digit/value, results in a different hash value. A different hash value makes any form of manipulation immediately detectable.

Smart contracts and smart property are blockchain-enabled computer protocols that verify, facilitate, monitor, and enforce the negotiation and performance of a contract. The term “smart contract” was first introduced by Nick Szabo, a computer scientist and legal theorist, in 1994. An often-cited example for smart contracts is the purchase of music through Apple’s iTunes platform. A computer code ensures that the “purchaser” can only listen to the music file on a limited number of Apple devices.

More complex smart contract arrangements in which several parties are involved require a verifiable and unhackable system provided by blockchain technology. Through blockchain technology, smart contracting often makes legal contracting unnecessary as smart contracts often emulate the logic of legal contract clauses. Ethereum, the leading platform for smart contracting, describes smart contracting in this context as follows:

Ethereum is a decentralized platform that runs smart contracts: applications that run exactly as programmed without any possibility of downtime, censorship, fraud or third party interference. These apps run on a custom built blockchain, an enormously powerful shared global infrastructure that can move value around and represent the ownership of property. This enables developers to create markets, store registries of debts or promises, move funds in accordance with instructions given long in the past (like a will or a futures contract) and many other things that have not been invented yet, all without a middle man or counterparty risk.

1. Disruptive Innovation

Blockchain technology has vast disruptive innovative properties. Despite the very early stage developments in blockchain technology, the possible applications are near limitless. For example, until recently, most commentators viewed Bitcoin as a hype, susceptible to fraud, price manipulation and corruption. Yet, the pace of innovation in cryptocurrencies and their application in different industries and commercial settings is faster than ever. The high levels of investor activity in the blockchain area appears to provide a reliable indicator of the commercial maturity of blockchain technology. The VC investment in startup companies that utilize blockchain technology has increased exponentially since 2012. Investor interest in the technology will undoubtedly further increase. Particularly, the applicability of blockchain-based smart contracts to digital marketplaces, the sharing economy, the Internet of Things (IoT) and artificial intelligence will further accelerate its development.

Blockchain technology startups have the potential to create lasting societal changes. Some predict a future in which such blockchain startups can remove intermediaries altogether from commerce as smart contracts in the blockchain, such as the ones in the Ethereum platform, regulate commerce entirely, enabled by the trust created between parties through immutable blockchain technology.

Business, administrative, and legal processes that rely on legal intermediaries may become redundant because of advances in and acceptance and implementation of blockchain technology. Forms of keeping legal ledgers such as notary and registry services, legal motions practice in court, legal title companies, among several others, may be among the first services to disappear in the not too distant future.

Similarly, corporate processes that have ledger functionality but rely on legal intermediaries could be streamlined very quickly by implementing blockchain technology. When blockchain technology becomes more widely accepted and applications are spreading into consumer territory, existing legal/financial/backoffice processes and structures will likely be among the first processes to become redundant.

The combination of blockchain technology startups with platforms, artificial intelligence and machine learning offer opportunities for developing new technologies. Leveraging the big data that is collected by using FinTech solutions and blockchain applications in combination with machine learning creates more creative and faster tools. This, in turn, creates a surge of new and innovative platforms with disruptive effects for the many industries.

2. Limitations

Blockchain technology and smart contracts executed on blockchain technology platforms, such as Ethereum.org, are faced with possible technological and legal limitations. First, the world of blockchain and smart contracting has not yet reached maturity. While blockchain enabled smart contracts generally do not require legal involvement across the spectrum of transactions, legal professionals often still believe that “code” in smart contracts can only deal with very simple transactions, such as buying music or perhaps a car, arguing that more complicated legal arrangements will necessitate the draftsmanship and negotiations of traditional lawyers. Even if more complex transactions could be coded and included in smart contracts, a widespread believe in the legal community suggests that lawyers will remain responsible for drafting the terms and arrangements that would later have to be coded by specialists.

Legal limitations pertaining to smart contracts and blockchain technology originate mostly from concerns over the legal origin of smart contracting. While smart contracts may reflect the underlying contract between parties, lawyers may argue that “smart contracts” are void and unenforceable under the law. Contractual legal rules regarding formation, interpretation, conditions and remedies require substantive adjustments of smart contracts in contract law.

The Blockchain evolution in combination with smart contracting also raises legal concerns regarding:  privacy, data protection, security and integrity. While blockchain technology itself offers unprecedented genuine data and privacy protection, the storage of blockchain data across a global network of nodes often will not comply with specific consumer protection rules, directives, and guidelines around the world. The existing legal issues arising in the context of sharing platforms, demonstrate that future blockchain-enabled sharing services may not be accepted quickly and without resistance on the part of incumbents challenged by new ways of delivering a service or product.

Blockchain technology and smart contracts executed over the blockchain face many of the same limitations other new technology companies face. The lack of maturity has slowed the progression of integration into the corporate world. There is still a lack of legal framework for the industry to work with, which causes uncertainty. Without knowing which laws apply, the whole industry is operating in a grey area of the law.

By operating in a grey area of law, a new level of volatility is introduced. Once Congress adopts a policy on the treatment of blockchain services, companies will be better able utilize the technology in a more legal and efficient way.

Another issue the blockchain community has seen is when Ethereum introduced what is known as a Decentralized Autonomous Organization (DAO). The DAO was launched in May 2016, in an attempt to set up a corporation like organization without the traditional structure. The DAO did not have a physical address as it was merely computer code.

During a fundraising period, the DAO raised roughly $168 Million from around 10,000 participants. Unfortunately, the code had not yet been perfected and hackers were able to take a third of the DAO tokens and transfer them into another account. This hack and other technological limitations, led to the demise of the DAO.

III. Disenfranchised Communities in Corporate America

Unlike their Caucasian peers, minorities still face obstacles in corporate America that affect their ability to succeed. Perhaps the most common method of assessing business success is the is expediency and degree of promotions in corporate America. Breaking into upper management ranks typically requires not only a high level of technical skill and understanding of the respective business, but also requires significant abilities to navigate the political environment. Because of societal perceptions of minorities, minority groups face an uphill battle in navigating the political environment in corporate America, which in turn can significantly affect their positioning and success in corporate America. However, some evidence exists that minorities can overcome the promotion gap in corporate America if they are seen as value enhancers by their superiors. If minorities are promoted, they often share common characteristics which can be predictors of minority success: “(a) is both a risk-taker and overly confident, (b) is a team player, and (c) is perceived by the employer to have the capacity to manage other non-whites.”

1. Corporate Structure

The corporate structure in America influences whether and at what rate minorities are promoted. For instance, promotion to high level executive positions often involves skillsets that are assessed subjectively, such as leadership skills, personality, judgment, attitude, initiative etc. Such criteria allow supervisors and managers to apply criteria that facially seems objective, but can be distorted with relative ease. Moreover, if minorities are promoted, they don’t necessarily use their new position to promote other minorities. In other words, in the existing corporate structure in American, minorities often have incentives to race to the top lifting the ladder behind them. Several factors support this finding. First, the corporate culture in America is individualistic and aggressive. Second, top management are supported so long as others in the corporate structure continue to hold them in power. This gives them an incentive to keep the upper management the same. If upper management allows others into positions of equal or greater power, the possibility of them being squeezed out increases.

Mentoring and targeted recruitment can help minorities break through the discriminatory incentives in the existing corporate structure in America. Programs that did not support changing the workforce composition included diversity training, diversity performance evaluations, and grievance procedures. In programs that did not work, managers were often defined as the source of the problem. Some of the more successful programs involved task forces and targeted recruiting efforts which engaged the managers in finding solutions. Mentorship with a superior manager helped minorities to be successful. Such success stories seem to suggest companies should focus more on mentoring programs and less on the formal evaluations.

The corporate structure in America is bound to change in the coming years because of the shift in labor markets. Since the early 2000’s, the percentage of minorities who are earning bachelors and graduate degrees has increased. This data suggests that a business imperative for hiring minorities will be created because corporations expanded their labor pool to include minorities, given the overall tightening in the labor markets, will create an advantage for themselves over corporations that have limited access to diverse workers.

2. Corporate Culture

Corporate culture can be defined by core commonalities in the way corporations are managed. Understanding corporate culture can help minorities gain a general understanding pertaining to the reason they are not promoted at the same rate as their Caucasian peers. By recognizing these reasons enable minorities to take steps to overcome these barriers to entry in the corporate world.

The Glass ceiling experienced by minority groups in America corporate culture can manifest itself in many ways. The most common identifiers of the glass ceiling include lack of training, lack of mentors, informal recruiting processes, wage gaps despite comparable work, and placement in a job with little growth opportunity. Any of these manifestations of the glass ceiling undermine a minority employee’s career progression and can have associated long-term effects on minority employment and community development.

Several core factors help explain the role of corporate culture and its effect on minorities in America. The clone syndrome, e.g. companies desire to hire people that are similar to the existing work-force, can lead to minority underrepresentation in corporations. The clone syndrome makes it difficult for a minority and women to break into a job predominantly held by white men. Similarly, if a corporation lacks diversity and allows group thinking, the board will likely struggle to identify issues because the corporation needs a fresh perspective. This can harm the corporation in the long term as it is less able to identify strengths and weaknesses. Changing the mindset of the corporate environment may require challenging basic assumptions of the men in charge. By not speaking out against sexist or racial comments, the corporate culture of an organization can increase the acceptability of such comments.

The discriminatory effect of existing corporate hierarchies may have their origin in the education system. Children in struggling school systems lack access to resources that better functioning school system in other districts can make available. Starting a career with lacking educational resources requires harder work to overcome barriers. Without access to the same resources, careers in corporate America are automatically geared towards those children that received the required resources. Accordingly, Caucasians dominate education, business, and politics.

3. Boards of Directors

Diversity on boards of U.S. corporations has been divisive for many decades. Whereas in the European Union board diversity has already been accomplished to some extend by mandating the participation of women on boards, board diversity in U.S. corporations is still largely elusive. According to some estimates, the lack of inclusion of minorities in corporate America costs the U.S. economy $1 trillion per year, taking into account the pay gap between whites and minorities. The structure of corporations and the role of corporate culture help explain part of the reasons for lacking board diversity in the United States.

Board diversity benefits corporations. By allowing minorities on the board, creativity increases with the different perspectives represented by minorities which acts as a defense against groupthink. While corporations also arguably have a social and moral obligation to celebrate diversity, business leaders typically look for business reasons to include minorities. Fiduciary obligations of the board may provide additional business reasons for board diversity. Board members are obliged to take actions that are in the best interest of the corporation. The board is required to act in good faith and make decisions the board reasonably believe to be in the best interests of the corporation. Directors must act after they have gained sufficient relevant information or data pertaining to the transactions in question. Arguably, a diverse board helps protect against group thinking which is in the best interest of the corporation.

Board inclusion can create risks for minorities. Minority board members are held to a different set of expectations than their Caucasian counterparts. Because board members are expected to interact with clients in order to help drive shareholder value, the minority board members are often expected to help bring in a minority clientele. However, if the product the respective corporation produces is not used by minorities, the minority board member will be perceived as a failure for not bringing in minority clients. This may stigmatize minority board members and impact their careers. Moreover, minority board members are often overextended because they tend to sit on too many boards that wish to show diversity. By having a small group of minorities who serve on a large number of boards, corporations are in fact losing the diversity of viewpoints they were initially looking for in a minority board member.

IV. Blockchain Solutions for Disenfranchised Communities

Blockchain technology holds great promise as a technology solution for disenfranchised communities. It is well established that blockchain technology holds great promise as an internet-like technology. Its anti-discriminatory and equality enhancing features have received less attention in the literature.

1. Blockchain-Enabled Trust as Anti-Discrimination

Blockchain technology allows an unprecedented increase in trust between anonymous transacting parties. Blockchain’s digital signatures enable a hightened level of security for society through transparency, eliminating errors and fraud within the network. The decentralized network enabled by the technology allows multiple copies of any transaction to be accessible to all members of the community for verification, making the reversal, alteration or erasing of information nearly impossible. Cryptographic hashes further increase trust and security of blockchain transactions by evaluating previous transactions using a complex algorithm before adding a new block to the chain. If the hash value is even incrementally off, the new block will not be added to the chain and any change or manipulation becomes immediately detectable by others in the network. Finally, Blockchain technology’s consensus model, e.g., the network of nodes agrees on the validity of a certain transaction and only the agreed upon and perfected transactions are recorded on the blockchain, allows a technology-enabled unbiased transactional verification mechanism that is unprecedented in centralized legacy systems.

The trust developed through blockchain technology benefits disenfranchised communities. Blockchain technology’s consensus model enables an unbiased transactional verification mechanism for known or anonymous parties. By establishing a network of transacting parties that trust each other despite anonymity, the technology enables unbiased transactions and eliminates prejudices against minorities. The transaction parameters or products are judged by the transacting parties based on quality perceptions not based-on other less rational and biased factors. This allows quality of the transaction and/or final product to be the true deciding factor in the market place, eliminating prejudices. Users can join the blockchain-enabled crypto marketplace without fear of prejudices from superiors in traditional corporate hierarchies. This eliminates bias-driven inefficiencies in the market economy and the associated diseconomies of scale and waste, which have been estimated at around $1 trillion dollars annually in the existing centralized business infrastructure. Corporations and society at large benefit from less biased and accordingly more efficient processes.

2. DAOs as Equalizing Organizations

A prominent example that helps illustrate the potential of blockchain-based organizations that support non-discriminatory practices and limit the impact of existing corporate hierarchies and their discriminatory effects on disenfranchised communities is the decentralized autonomous organization (DAO).

The DAO was launched in May 2016, in the founders’ attempt to set up a corporate-type organization without using a conventional corporate structure. The founders’ central idea was that the wisdom of the crowd would lead to smarter and more game-changing investment decisions. The DAO had to operate as a kind of venture capital fund managed directly by the token holders.

The DAO governance structure was built on software, code and smart contracts that ran on the public decentralized blockchain platform Ethereum. The DAO did not have a physical address as it was merely computer code. And it was not an organization with a traditional hierarchy as we know it from traditional corporate structures where authority and empowerment flows downwards from investors/shareholders through a board of directors to management and eventually staff. Indeed, it had no directors, managers or employees. Because a series of smart contracts granted DAO token holders voting rights, the blockchain-based smart contracts imitated the role of articles of association or bylaws. Because the DAO code was open source, the token holders would not only vote on “investment proposals”, but also on any change made to the code. Accepted proposals would also be backed by a software code, defining the relationship (in terms of rights, obligations and performance metrics) between the DAO and the funded proposals.

During a crowdfunding campaign in May 2016, all investors could become a DAO participants by purchasing DAO Tokens. The DAO raised more than $168 million from approximately 10,000 “investors”. DAO Tokens were designed to be fully transferable and tradeable on “peer-to-peer” exchanges, similar to shares in a traditional listed corporation. The automated structure was intended to give “participants” in the DAO direct real-time control over contributed funds. Alas, things went terribly wrong with the DAO. Fundamental flaws in the DAO code enabled hackers to transfer one third of the total funds to a subsidiary account. This hack in combination with additional technological limitations brought down the DAO initiative.

People who work for a DAO are free from existing corporate hierarchies and their possible discriminatory effects. People who work for a DAO would not be subject to a supervisor, boss, or CEO. Instead, one works in a dynamic set of working relationships that continuously and dynamically self-organize around projects and outcomes, not corporate hierarchies with implicit hierarchical biases that discriminate against minorities or people from disenfranchised communities that have not been able to work in the expected parameters of the existing corporate hierarchies in terms of background, education, etc.

Disenfranchised communities will increasingly be able to afford the buy-in into a DAO. The increasing access to DAOs eradicates a possible income based or wealth based bias because participants in the DAO are required to buy into the DAO. People who wish to work in a DAO structure are required to acquire a coin or token, whose ownership is recorded in the DAO blockchain. Currently, the most common access point involves buying cryptocurrencies, such as Ether or Bitcoin, with existing currencies such as US dollars and using such cryptocurrencies to acquire coins or tokens the respective DAO one wishes to join.

The compensation afforded to DAO members can take the form of increases in value of the DAO token the members own or can take the form of earning tokens by performing tasks for the DAO. Because the total outstanding and publicly held supply of tokens for any given DAO is fully transparent and pre-determined in code, the value of the respective DAO tokens increases along with demand. Moreover, because the total supply of tokens is pre-determined in the DAO code, dilution by central administrators such as government officials or self-interested or biased executives/supervisors/CEOs is impossible, which further illustrates the power of blockchain structures such as the DAO. Accordingly, compensation of DAO members originates from supply and demand. Importantly, the compensation of DAO members can also take the form of earning tokens by performing tasks for the DAO. In other words, people / token holders can earn a separate income in addition to token value appreciation by supporting the DAO achieve its objectives.

Disenfranchised communities benefit from the core distinguishing characteristics that separate the DAO from traditional organizations. Unlike a traditional organization, the priorities and work schedules of DAO members are not determined in a classical top-down corporate hierarchy. In fact, the traditional forms of command and control, giving and receiving orders does not exist because the functionality of a supervisor, CEO of boss does not exist in a DAO structure. While token holders in the DAO community may identify DAO requirements or needs, such as for instance a new or optimized webpage that helps the DAO community, such requirements are not identified in the form of a mandate. In other words, no particular DAO member is tasked with performing the identified optimization. In other words, disenfranchised communities who become DAO members are not required to perform tasks in a classical corporate hierarchy that they either cannot enter or are ill-equipped to function in, given the traditional demands of such hierarchies on education, background, and cultural fit.

Disenfranchised communities benefit from the non-hierarchical performance expectations in a DAO structure. First of all, a common denominator for all DAO token members is the unifying desire to optimize the DAO structure and the DAO token value. If a member-identified optimization has the potential to make the DAO more meaningful, useful, or valuable to the token holder members, the DAO token holders will desire to perform such optimization tasks as it is in their very interest to do so to help increase the value of the DAO tokens. Accordingly, token holders are determined to increase the value of tokens rather than lower the value. To increase the value of its tokens, members can make DAO optimization proposals, e.g. optimize the webpage, that explain what actions ought to be taken to optimize and what value such actions will add to the respective DAO token holder community. The token holder community then votes on a given optimization proposal. If a proposal passes, the proposing DAO member will receive an award in the form of new tokens. Any such payment is added to the respective DAO blockchain but now requires for the proposing token holder to perform on the proposed parameters of optimization. In other words, once the optimization proponent has made a deal with the DAO, it’s in the blockchain and the proponent is required to deliver on the proposal or her contract is cancelled.

For disenfranchised communities working in a DAO structure this means they will not and cannot be judged by race or cultural biases. Instead, their performance in an anonymized proposal voting scheme is the only basis for assessment and payment. If they perform well, they will get remunerated regardless of politics (there are none), background, or education. The only thing that counts is performance of optimization parameters. This is an important difference between classical corporate hierarchies and DAO member performance of optimization proposals, e.g. the DAO’s non-discriminatory performance measures.

Non-performance penalties in the DAO structure are free from racial or cultural biases. If disenfranchised community members do not deliver on a proposal that was voted in by the DAO token holder community they lose credibility in the DAO token holder community and may be perceived as lacking an ability to add value. In fact, non-performance on proposal comes with significant reputational penalties and non performers in the DAO structure will be less likely to have future opportunities to earn tokens because the other token holders are unlikely to approve non performer proposals. Crucially, non-performance reputational penalties are entirely free from racial implications as the token holders are unlikely to even know each other. Rather, they all work towards a common goal of optimizing the DAO and the token value.

The DAO token holders’ focus on adding value benefits all constituents. Because projects that cannot add value take token holders’ time away from more productive endeavors, token holders become focused on managing their time and efforts. Unlike in traditional hierarchical organization where face-time and unproductive meetings are the norm, the self-governing DAO token optimizer avoids any such corporate hierarchy inefficiencies and frees herself from top-down inefficiencies and bad outcomes. In essence, the DAO work proposal and value optimization structure allows the avoidance of bad projects, bad colleagues, and unproductive meetings as the only thing that counts is the value proposition. In other words, the focus shifts from political positioning and supervisor pleasing without performance to a laser sharp focus on adding active value to a given project. If value can be added, the tasks will be performed, if the assessment of the proposal suggests that the value proposition is in doubt token holders will try to spend their time and skills on more productive and value-adding tasks. Importantly, because the DAO structure functions without supervisors DAO token holders who decide they cannot add value on a given task can move to more productive endeavors that better utilize their skills without any penalties that would exist in the traditional hierarchical corporate structure.

Politics in the DAO structure have a different nature compared with traditional hierarchical corporate structures. In a traditional corporate hierarchy, position in the hierarchy and associated authority determine effort. In other word, the supervisor in the hierarchical structure can determine where, what, and when workers have to perform, resulting in suboptimal outcomes, attendance of unproductive and useless meetings, among many other negative effects. By contrast, in the decentralized DAO environment, influence is determined by the value a given token holder contributed to a project’s success. If a token holder adds substantial value to the DAO, other DAO token holders will want to add their skills in the same context which focuses the token holders’efforts on the highest possible value proposition. This “value to effort focus of work flows in the DAO structure has the potential to revolutionize the way society works. At the same time, the value to effort focus of work flows makes racial and cultural biases much less pronounced and protects disenfranchised communities.

In summary, DAO token holders have enormous incentives to create value for the DAO based on their respective beliefs and skillsets and not based on expectations of supervisors in traditional top-down corporate hierarchies. In other words, the DAO value creation efforts by DAO token holders is free of implicit racial biases and cultural norms, helping to create a freer and less unequal society.

V. Conclusion

Equality is a natural byproduct of the blockchain-driven evolution of the crypto economy. Blockchain’s trust enhancing consensus model, smart contracting in anonymous networks, and DAOs allow for the evolution of a more equal society. Human biases are less likely to survive in a decentralized networked society which benefits not only minorities but society at large.

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:

Blockchain Technology’s Distributed Jurisdiction

By Wulf A. Kaal & Craig Calcaterra

 

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Prof. Wulf A. Kaal, Ph.D. 

CraigPic

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. The Ties Network demonstrates that anonymity can be perpetuated in blockchain technology, despite blockchains’ eternal storage of information and its growing size working against anonymity. The Aragon Network highlights that the technology itself offers means of internal controls that help ensure effective governance in the continuing evolution of the technology.

Introduction

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.

Lack of Regulatory Recognition

The lack of regulatory recognition of blockchain technology creates uncertainty for the blockchain community. The lacking recognition hinders the implementation of the technology across industries and undermines infrastructure conversion via blockchain technology. The regulatory uncertainty derives from insufficient or non-existent regulatory guidance, sparse court decisions, uncertainty over jurisdiction, and a sense in the user community of interacting in an environment that is generally free of law. As the technology applications grow and the value of crypto currencies rises, the evolution of blockchain-based crypto economy will depend to some extent on users’ trust in the efficacy of blockchain-based dispute resolution mechanisms and the immutability of the technology.

Courts have not yet recognized blockchain technology or addressed legal implications of blockchain-based applications. For the most part, the technology industry agrees that blockchain technology is immutable and secure. However, a review of published court opinions suggests that no court has had to review, assess, or scrutinize the uses and applications of blockchain technology at the time of publication of this article, which creates uncertainty in how courts may perceive and treat blockchain technology.

Some may argue the technology is no different from other virtual technology that courts have evaluated. However, we claim that blockchain technology provides a challenge that is qualitatively different from any other technology that has been brought to traditional courts in the past.

Blockchain ledgers do not exist in a physical sense, and therefore have no specific location. The blockchain is distributed, meaning the nodes in any public blockchain network can be located all over the world. Arguably blockchain transactions can therefore be subject to the legislation of any given node in the network. However, the nodes themselves are autonomously run, extremely redundant, and may be anonymized with encrypting protocols.

Therefore, the infrastructure does not fall under any traditional jurisdiction, but the users of the infrastructure also naturally evade any sense of traditional jurisdiction. All parties may transact entirely anonymously on a public blockchain.

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. Every user on a public blockchain is anonymized by the use of public-key encrypted identities. The tandem use of virtual private networks (VPNs) can then prevent 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. The transparent, public, and perfectly logical structure of a smart contract could theoretically improve communication in such a negotiation. 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 unnecessary. A bounty contract for anonymous work allows an anonymous person to put a bounty on a given job and offer such 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.

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 could be argued that breach of a smart contract is not technically possible: the contract is entirely coded with mathematical logic and 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 identities of 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 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 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.

Securing Anonymity

The current blockchain characteristics undermine the continuing anonymity of blockchain-based transactions. Anonymity removal in blockchain transactions is a serious problem that in fact undermines the evolution of the technology as it undermines trust in the technology-supported transactions. First, because the blockchain is immutable, blockchain-based transactions will be eternally stored and cannot be removed or deleted. Eternal storage itself works against anonymity. Second, as blockchain-based transactions increase in popularity, the size of the blockchain grows rapidly which will eventually require special equipment that can only be afforded by large corporations in the existing legal infrastructure. With such power for large corporations comes the possibility of dangerous centralization and a threat to undermining anonymity.

Automatic Blockchain Solutions

In a simple sense blockchain technology provides its own solutions for jurisdictional issues, governance, and conflict resolution. Blockchain technology resolves disputes of contracting parties by calculation. If a transaction is invalid it is checked automatically and quickly by any node and ignored. This is the inherent meaning of “self-executing, self-regulating”. If two competing/contradictory transactions are valid, then the system automatically resolves the primacy of one over the other according to computing power. Whichever transaction is embedded in the longer computation chain will have primacy. No decisions can be made once a transaction is added to the network. No governing body currently exists to petition for recourse.

Aragon

Despite the dispute resolution mechanisms embedded in blockchain technology, smart contracting in a commercial setting will eventually require additional dispute resolution mechanisms. Problems with smart contracts are inevitable because of the subjectivity in human relationship, bounded rationality of coders and contracting parties, incomplete foresight, incomplete information, and opportunistic behavior. Such human limitations will eventually make breaches or other problems in smart contracts inevitable, despite coders’ attempts to optimize code in an effort to avoid such human traits in smart contracting. Add software and coding bugs to the human limitations and conflict resolution mechanisms become a necessity in the evolution of the crypto economy.

The Aragon Network already suggests dispute resolution solutions that can help the consumer acceptance of smart contracting and crypto transactions. Aragon will use a form of digital jurisdiction governed by a representational democracy of anonymous judges and regulators, whose power is based on their stakeholder share of the network and supplemented by a reputation system. Whenever a user wishes to dispute the execution of a contract in the Aragon Network, they post a bond (which will be returned if the dispute is decided in their favor) and a brief of their argument. 5 judges who have posted bonds will be randomly selected from all the users of the network. The judges read the litigants’ briefs and issue their judgements. Majority decisions determine the outcome of the dispute. If a judge ruled with the majority, they are rewarded monetarily; if not, they are punished with the loss of their bond. 2 appeals are possible. If either party disagrees with the judgment they may appeal by posting a larger bond with their argument. This opens a prediction market, where any user in the organization may become a judge by posting a bond. The arguments are read and all judges return their verdicts. Again majority determines the result of the dispute, with rewards or punishments for judges are given based on whether they sided with the successful party. The final appeal is made to a panel of 9 “supreme court” judges comprising the most successful judges in the network. A larger bond is posted by the appellant at each stage to prevent the wasting of system resources.

Ricardian Contracts – OpenBazaar

OpenBazaar is a distributed program that provides an online trading platform for any type of merchandise using cryptocurrencies. It does not use a blockchain for its core architecture, but it is a distributed network and all parties and transactions are anonymous. Because of these core elements in the OpenBazaar network we consider it appropriate to compare its dispute resolution mechanism.

The essential ideas of OpenBazaar’s system can be profitably employed on general distributed and anonymous business transaction platforms: 1. If both parties can agree on the type of transaction they are performing before signing a contract, a particular pool of arbiters can be chosen automatically. 2. A pseudonymous web of trust can be implemented to generate reputation for arbiters without compromising anonymity.

A core feature of the OpenBazaar dispute resolution mechanism involves so-called notaries. In the event of a dispute between parties, assuming alternative dispute resolution (ADR) had failed, the system includes a third party – the so-called notary. Users may choose not to involve the notary from the beginning of a transaction, in which case the smart contract has no transaction fees. However, the payment option without notaries involves risk because in that case, no arbitration is possible. The notary’s primary job is to electronically verify the contract has been signed by both parties and funds are available in escrow. Second, the notary verifies both parties are satisfied the terms have been fulfilled, then releases the bitcoin from escrow to the vendor. Finally, in case either party is not satisfied with the transaction, the notary acts as an arbiter in the dispute.

The allocation of notaries to contracts is an important mechanism for comparison of dispute resolution mechanisms. Similar to Aragon, notaries in the OpenBazaar system are generally randomly chosen and allocated to a given contract. However, in OpenBazaar the creators envision assorted pools of private notaries with varying expertise. Parties can theoretically agree which pool of notaries to choose before the contract is signed. This mechanism encourages the development of expertise within the system while satisfying the overarching goal of maintaining the anonymity of vendors and customers, since the details of a dispute are kept secret assuming the professionalism of the randomly chosen notaries.

The anonymity of the notaries is crucial to keep the system secure. Without anonymity, notaries could be coerced into revealing private information revealed in a given party’s case. Therefore, the notary pool is reviewed using a pseudonymous web of trust to determine reputation. Pseudonymity is achieved using public keys.

OpenBazaar provides many benefits to disputants that are not included in the Aragaon dispute resolution approach. Similar to Aragon’s system of appeals, OpenBazaar imagines an appeal system that includes randomly selecting new notaries from the agreed upon pools according to reputation. However, OpenBazaar’s more complex structure giving disputants the power of selecting between notary pools is a clear improvement over Aragon’s method of completely random selection from the entire group of users posting judge bonds. OpenBazaar’s approach naturally encourages notary pools to develop expertise in the various fields of law. Even though there is a chance that disputants’ private information may be revealed in the course of a dispute, the reputation of a notary depends on their professionalism in maintaining the privacy of their clients.

Aragon’s whitepaper is not specific about how much private information is broadcast to the blockchain, but it seems to suggest their judgements have minimal information. In fact, Aragon appears to not even post a summary of their arbiters’ reasoning which may cause the losing party to second guess the legitimacy of the entire dispute resolution mechanism in Aragon.

Limitations of Existing Solutions

Despite its much-needed introduction of dispute resolution and smart contract optimization improvements of the Ethereum network, the Aragon network still encounters several limitations. First, without full and continuing anonymity throughout the crypto evolution, the application and evolution of Aragon’s distributed dispute resolution mechanisms may not be viable in the long run as traditional jurisdictional means would attempt to take over without the assurance of full anonymity in blockchain transactions. Second, the random selection of judges from users of the Aragon network may only limitedly ensure the effective dispute resolution. Over time, users will inevitably demand the highest possible expertise of their judges and arbitrators. Without judge’s expertise in a given smart contract subject matter of a dispute user confidence in effective and fair conflict resolution is undermined which leads to overall less confidence in crypto transactions as a whole and can undermine the evolution of the crypto economy. Third, the democratic decision of a majority of judges giving binary decisions in the Aragon dispute resolution in combination with its judges’ lack of verifiable expertise may undermine user confidence in effective and fair dispute resolution. Fourth, users in the Aragon system would only informally be able to use lawyers or other consultants and perhaps would use lawyers from the existing jurisdictional infrastructure to help optimize their arguments in support of their claims. Support from lawyers trained in the existing jurisdictional infrastructure and without additional training in quantitative science and coding can lead to suboptimal results for transacting parties in smart contracts. Fifth, Aragon does not allow opting into different dispute resolution mechanisms. Only a user of Aragon can use their dispute resolution mechanisms. As other smart contracting platforms are being created, a need for more diverse, nuanced, and effective dispute resolution options emerges.

Several additional factors suggest that the dispute resolution scheme in Aragon could be improved. The random selection of user judges in the Aragon network introduces a level of arbitrariness to dispute resolution mechanisms that many private users but especially larger entities, including corporations in the existing legal infrastructure may not appreciate. Especially the submission of judges to the more popular vote and the economic incentives for judges to follow a more popular vote (in the Aragon system judges keep their bond if they voted with the majority), despite the overall anonymity of the voting, may call required notions of effective, non-arbitrary, and fair dispute resolution mechanisms into question. Users who are dissatisfied with such suboptimal conflict resolution mechanisms may wish to opt into a more nuanced conflict resolution network that helps them ascertain their rights and guarantees balanced outcomes.

Similarly, the OpenBazaar supported Ricardian Contract is subject to multiple shortcomings. Technically OpenBazaar does not use smart contracts. Instead “Ricardian” contracts are used, which have one extra layer of identification between the human-readable version and the code-readable version of the contract. The performance of the Ricardian contract is not always completely self-executing, and hence needs the third-party notary. The primary disadvantage of OpenBazaar’s system, compared with Ethereum’s smart contracts, is this extra layer of verification and the associated transaction fees. Because of these fees, the OpenBazaar dispute resolution mechanism creates substantial transaction costs that can be avoided by pure Ethereum-based self-executing smart contracts. Because every disputable Ricardian Contract has an arbiter/notary connected with them to automatically, check the contract, and hold funds in escrow until the contract is validated, such contracts follow the established legal order for contracting to a significant extent. Despite the clear gains they achieve with distributed, anonymous computing, still significant additional transaction costs remain because of the associated notary intermediator. Smart contracts make such transaction costs unnecessary but need a sound system for dispute resolution which we herein propose.

Proposal for a Distributed Jurisdiction

To address the above limitations, we recommend the creation of a distributed jurisdiction in the blockchain with the following tenets.

First, parties should agree on a pool of arbiters before the contract is signed. Random arbiters are elected from the chosen pool in the event of a dispute. This encourages specialization and the development of expertise within the community of anonymous arbiters.

Second, arbiters within the pool give written summaries of their judgments. Such explanations lessen claimants’ dissatisfaction in traditional courts, and opens the possibility for more nuanced resolutions.

Third, arbiters’ reputations are determined by a pseudonymous upvoting system of their judgment summaries. This may be protected from Sybil attacks by proof-of-timelock protocols and/or representative democracy based on reputation. This quickly improves the expertise of the pools while protecting anonymity, as judgments which reveal private information will be quickly discouraged with downvotes.

Conclusion

This article highlights the need for creating blockchain-based jurisdictional means as a basis for emerging conflict resolution mechanisms. Solutions for the incompatibility problem between blockchain technology and the existing legal jurisdictional infrastructure will evolve with the evolution of the technology itself.

While conceptually we believe in the incompatibility of the crypto evolution via blockchain technology with the existing regulatory infrastructure, it is important to appreciate the many gradations of blockchain technology and its broadening application bases. Given the gradations, it would be imprudent to claim perfect and universal solutions to the incompatibility problem we highlight in this article. Still there are some general principles that are applicable to broad situations.

We recommend the creation of a distributed jurisdiction in the blockchain which includes pools of randomly chosen arbiters based on reputation determined by an upvoting system.

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
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