The Sidley Podcast

Blockchain: Poised to Transform Business

February 24, 2020 Sidley Austin LLP
The Sidley Podcast
Blockchain: Poised to Transform Business
Show Notes Transcript

Blockchain technology has the ability to transform how business and everyday commercial transactions are being done across industries. This emerging technology represents more than just an incremental improvement in business practices — it could actually disrupt how we do business. What is blockchain, how will it affect the way we communicate and transact with each other and why are cryptocurrencies being used in conjunction with this technology? 

We get answers to these questions and many others on the latest episode of The Sidley Podcast. Podcast host and Sidley partner Sam Gandhi speaks with Lilya Tessler, a partner in the firm’s New York office, who focuses her practice on the corporate and regulatory aspects of blockchain technology.

Speaker 1:

Technology can be disruptive and perhaps none more so than blockchain. It's more than just the foundation for cryptocurrencies like Bitcoin. Blockchain promises to change the way everyday commercial transactions are handled and threatens to disrupt how we conduct business. But what is blockchain and what's changed in the landscape to make it so attractive to business? We'll find out in today's podcast,

Speaker 2:

anyone around the world can use this technology and transact at lightning speed. We're certainly seeing a lot of early adopters that are in the process developing the technology. We're seeing a lot of interesting implementations in the insurance space, especially with the use of smart contracts, which is an application that can be built on top of blockchain technology. The most important part of getting in early is really being part of the decision making process, helping build the infrastructure to be tailored to your particular business

Speaker 1:

from the international law firm, Sidley Austin. This is the Sidley podcast where we tackle cutting edge issues in the law and put them in perspective for business people. Today, I'm Sam Gandhi . Hello and welcome to the podcast. There's a lot to learn about blockchain and there's no one better to explain it than our guest today. Lily Tesler , Lily's a partner at Sidley Austin and head of Sidley's , New York, FinTech and blockchain group. Lily focuses her practice on representing digital asset trading platforms, blockchain technology companies, U S and non U S broker dealers, financial services firms, and cryptocurrency funds. Lily also advises technology companies on blockchain token offerings, including so-called initial coin offerings or ICS . Lily , welcome to the podcast. Thank you Sam. Happy to be here today. So many people don't understand the difference between blockchain and say Bitcoin or cryptocurrencies . I thought for a long time they were the same thing. What really is blockchain?

Speaker 2:

So blockchain is a distributed ledger technology. It is a database that's recorded across multiple computers around the globe that each record a carbon copy of that same data.

Speaker 1:

So is it kind of like a shared Excel spreadsheet?

Speaker 2:

Yeah , so share a shared spreadsheet, but that everyone verifies any data that's added to it and cannot be modified unless everyone on that network reaches agreement about new data that's added to it.

Speaker 1:

So that's a way for people to kind of share information. And how do they agree together on what data gets modified or added?

Speaker 2:

The agreement is called a consensus mechanism. So V various blockchains. Each one has its own consensus mechanism is the equivalent of a corporate governance structure that you have in a corporation . It's the same consensus mechanism that's applied for a network that's agreed to initially when the network is launched and cannot be modified unless a certain percentage of that network grease to a change to that governance structure. Why is it called blockchain? The data that's added to the ledger is added in blocks of information and it is secured using cryptography. So cryptographic keys are used in order to add new information to the chain and it's linked and so you can never once if the block is added can never be modified or changed in, in, in the blockchain ledger

Speaker 1:

unless everybody agrees. Yes. And how does somebody join the blockchain ledger?

Speaker 2:

There are different ways to join depending on the type of blockchain. So there is no one blockchain, but typically for an open source blockchain network, which are generally public blockchains, anyone can go on a public website that has the open source code, download that code and start running their own carbon copy of that blockchain and become a participant on that network.

Speaker 1:

Why do people want to use blockchain technology as opposed to the regular old way of contracting?

Speaker 2:

Well, there are a number of advantages. So first there's a level of transparency that the various participants on an network can have depending on the permissioning of each particular system. The technology is designed based on certain cryptography to be tamper resistance , so any party that participates can trust that no other party on the network can manipulate or change the data that's on that network. There's also a level of cost and speed that's achieved through blockchain. Anyone around the world can use this technology and transact at lightning speed that has never been seen before and it allows transactions on a peer to peer basis and cuts out potential intermediaries that would have traditionally been part of the transaction life cycle, which also improves cost and efficiency.

Speaker 1:

What are the industries that are gravitating more towards using blockchain technology?

Speaker 2:

A few of the most prominent use cases that we've seen first is in supply chain management. So global consumer retailer can get all of the vendors and participants across the supply chain on one shared network and so can track the Providence of any goods that make up any item from anywhere around the world, all on one shared system. That same system can be used to track invoices and bills of lading and payments among all of those participants. It can also be able to track the quality and of the goods that are being added to that network. So there are a number of benefits that we're seeing in supply chain management, for example.

Speaker 1:

So it seems like we're moving from a historically very centralized type of financial or contracting system to something that's more open and less centralized. Is that safe?

Speaker 2:

Certainly security is part of something that there are benefits that come with blockchain technology, but also certain drawbacks in technology. Then you need to be considered. So in the fact that there are shared access to the database and it's shared consensus mechanism, we discussed there is a level of security because no new information can be added or existing information be changed without all of the participants agreeing. So there is a level of security. It also really varies on what type of blockchain a company's using as a level of security. So security as part of the governance mechanism comes with scale. So the more participants that are on the network, the more that are sharing in the validation process, the more secure it is. So part of the security is how much scalability and adoption there is in one particular blockchain.

Speaker 1:

Right. But you talked about using open source software that anybody can kind of download. You know there's open source software from a website. Most of our clients, when we deal with them, they're very concerned about encrypted communications, safe email, not using public internet, et cetera. So if the technology uses open source software, how safe really is that?

Speaker 2:

What's open source is the actual code that is underlying the technology. So you can use it to verify how the code works and how it's designed. Anyone can take that open source code, actually create their own internal system using a variation of that code, but the data on that blockchain is not open source. Not everyone can see that data depending on which blockchain you're talking about. Even on a public blockchain like Bitcoin, you mentioned earlier a transaction from party a to party B. You can see that it happened, but you can't see through what that data is, who that person is. The actual data is secure.

Speaker 1:

The blockchain technology also I understand, lets participants be anonymous. Does that mean that parties who are using that blockchain technology don't know exactly who they're transacting with?

Speaker 2:

Only a small set of blockchains are designed to really truly be anonymous. Most blockchains that are public blockchains in order to create a public private key or transact on that blockchain, there is a verification process that you would need to go through, especially if you're transacting through exchanges or other regulated financial institutions. Everyone engages in AML KYC prior to facilitating those transactions. It's only a very small subset of blockchains that are being used for anonymous transactions or even private permission. Blockchains being used by financial institutions are all known actors that are involved in in that network.

Speaker 1:

You're listening to the Sidley podcast and we're speaking today with Sidley partner, Lily Tesler about the brave new world of blockchain and why it offers such promises and threats to the existing ways we do business. Blockchain technology I think has been around for about over 10 years. Why all of a sudden has a landscape change where businesses are more likely to use it now than before.

Speaker 2:

We're seeing a level of scalability and more mainstream adoption by businesses. It's taken time to have blockchains that can handle the amount and size of the data that businesses need to be able to be used on a global scale. Really, it's not a us phenomenon. It's being used throughout the world and you need a scalability element of, and so you need the right technology to be able to handle the amount of data that businesses need in order to transact.

Speaker 1:

Lily , who is adopting this technology? We've heard of financial institutions and on wall street hiring hundreds and thousands of computer programmers, but are they the ones really at the leading forefront of developing this technology and using it?

Speaker 2:

So we're seeing certainly bigger financial solutions or other enterprises adopting and evaluating how they can integrate the technology into their existing infrastructure, but they already have existing databases and proprietary systems and the legacy systems are becoming much harder to integrate with this new technology. And so we're seeing a lot of emerging companies developing the technology, adopting it and getting to market faster because of how nimble they're able to be since all they have is the new technology as opposed to integration issue with legacy systems. But in addition, there are a lot of regulatory hurdles I need to be overcome prior to big financial institutions adopting this technology. And so that's why it's , we've seen it a slower adoption than typically of other technologies. What are some of those regulatory hurdles? The regulatory considerations we're seeing in in it that fit into four different buckets of categories would say first there's financial services regulations that apply to this technology regardless of whether it's a financial institution. So we're seeing securities laws, commodities laws, money transmission and banking laws, all relevant to the development and implementation of this technology. And at least here in the United States, we're seeing overlapping jurisdiction that the regulators are asserting on this technology. But the regulations like you mentioned, are not written for this type, these types of peer to peer transactions. And so that's something that we're, a lot of the Finnish students are waiting for the regulators to catch up and provide more guidance in this area. The second bucket we're seeing is privacy data security and consumer protection laws and how they apply to the data that's being recorded on this distributed ledger technology. And then we're seeing industry specific regulations. So as the technology is being adopted in different industries, there are regulations that may be applicable. For example, in healthcare there's HIPAA or in media, the FTC weighing in on how this technology can be implemented in, in that particular industry with their specific regulations. And then lastly, there's a whole host of miscellaneous regulations such as commercial law considerations and taxation. Others that need to be considered.

Speaker 1:

Well, we, we talked about how this technology is going to be changing how we transact business, how is it changing how we do everyday transactions [inaudible]

Speaker 2:

so for example, Sam, in the consumer facing world, we're seeing social media being revolutionized using this blockchain technology. Consumers will not at any point know that they're using blockchain technologies and underlying infrastructure. But some of the benefits that we're seeing is that the blockchain will provide a level of functionality we haven't seen before. So users on a social media platform can record the content and have it stored on blockchain technology. They can transfer that data to others, they can take control back of the data that they have, provide a level of privacy and transaction that they haven't in the past. And so it's also being used for a level of authenticity of that data.

Speaker 1:

Lily . There are other uses of blockchain technology that we've heard about. Do you refer to a supply chain? What are the other and most popular uses of blockchain besides digital currencies?

Speaker 2:

We're seeing a lot of interesting implementations in the insurance space, especially with the use of smart contracts, which is an application that can be built on top of blockchain technology with respect to providing for instantaneous recording of insurance policies and payments under existing insurance policies. So for example, one of the prominent examples typically use is in the case of a farmer that's looking to insure a frost event. And so they enter into an agreement with insurance policy company that writes a policy that if the weather drops below a certain temperature, they get an automatic payout. Those terms are programmed to a smart contract and so that technology can integrate with the national weather service, also known as Oracle on the blockchain. And as soon as the temperature drops, the technology can be programmed to automatically send out a payment to that farmer without the need to file an insurance claim to prove that the frost dropped. And if you are using a digital currency or other electronic payment, continuously send payment to that farmer or otherwise mail them payment and other means.

Speaker 1:

And so without even verifying whether the farmer is really the farmer because he's lost, he or she has lost all their records in the storm of the frost.

Speaker 2:

Yes, yes. So they'd be verified upon entering as a participant on the blockchain initially prior to the smart contract being executed.

Speaker 1:

So Lily , how is blockchain technology disrupting how businesses contract with people or how they operate their businesses?

Speaker 2:

So for example, we're seeing a lot of standardization with respect to contracts . So as I mentioned, smart contracts can be used to preprogrammed certain predefined terms and then that eliminates the need for negotiation or contract departments . Me negotiating all of the terms, it's only key business terms that can be preset and pre-programmed and then will self execute upon in the occurrence of certain events among the parties without the need for substantial negotiation. Especially with respect to what happens if things go wrong in the agreement, which is what a lot oftentimes is being negotiated in the contracts.

Speaker 1:

So does that mean we're going to eliminate or reduce litigation risk questions about vague contracts, things are going to get executed quicker. Is that the intent?

Speaker 2:

Possibly over time. That's what we'll see. But it's important to note that smart contracts have not yet been tested in a court of law, so there's no court that it said a smart contract is a valid legal contract. So oftentimes we advise clients to in parallel still maintain written paper contracts in the event that the smart contracts are not enforceable, but over time we may see everything in a digital format.

Speaker 1:

So the general counsel who is just hired 30 contract attorneys to look at contracts, are they going to hire 10 coders to do all that? Is contracting all going away for smart contracts and coders?

Speaker 2:

We're seeing a huge growth area in the blockchain technology coders space. Every major university has developed a tome blockchain educational program to help educate both technology individuals. But then we're also seeing law schools providing educational program on blockchain, the use of smart contract technology and how to integrate that with contracting programs. So I don't think it will make the contract process obsolete, but it will change the role of lawyers and how they interact with the technology over time.

Speaker 1:

Can businesses really avoid using blockchain?

Speaker 2:

Over time? We're going to see a number of blockchain use cases for various businesses. This technology is not going away. We're certainly seeing a lot of early adopters that are in the process developing the technology. Over time, businesses will have this technology integrated as different components of their business, but the most important part of getting in early is really being part of the decision making process, helping build the infrastructure to be tailored to your particular business. Otherwise, later on, you would just most likely be joining an existing blockchain network that's already been designed by your competitors or other parties in your

Speaker 1:

infrastructure. Is the U S a leader in blockchain technology or are there other countries that are, that are really taking the lead on developing this?

Speaker 2:

We're seeing certainly a growth in the U S but one of the regions that we're seeing the most growth is certainly Asia. The U S is trying to be a leader, but the regulatory uncertainty in the U S is driving a lot of the innovation to other parts of the world. So the regulatory considerations come hand in hand as to to which countries are developing the technology going forward.

Speaker 1:

Lily , let's move to digital currencies. And most people, when they think of blockchain, they think of Bitcoin or other types of digital currencies. What's the difference?

Speaker 2:

Bitcoin is a very first blockchain and the Bitcoin blockchain uses the Bitcoin token or digital currency to operate and run that infrastructure and value and reward miners and that blockchain to add new transactions. But that Bitcoin blockchain can be used by any company to build on top of and use for other business use cases. In the Bitcoin block chain , the primary governance is mining. And so all miners get rewarded for verifying transactions using Bitcoin. There's other blockchains that get verified using a staking mechanism. Where there , there's other digital currencies that are used to reward those validators that verify those trends.

Speaker 1:

Action . Can you explain what we mean by minors in Bitcoin?

Speaker 2:

So in order to verify and add new blocks, a blockchain transaction, various miners are big massive computers located are in different parts of the world that calculate mathematical formulas using cryptography to add new data to the chain. And the first computer that calculates the formula correctly and they're massive computers at different speeds operating, they are rewarded in the Bitcoin, for example, digital currency. And so this mass verification process using mathematical formulas is really what mining is.

Speaker 1:

So what you're saying is Bitcoin is really both, it's a both a digital currency, also a type of technology that people use to transact businesses within each other. Yes, that is correct. And if they transact using that technology, do they have to transact in Bitcoin or can they do it with any type of other digital assets

Speaker 2:

so they can transact with any, a digital asset or transfer any type of data on top of that blockchain, all you need the Bitcoin for is to operate the underlying technology and and verify new data or transactions that are added to that.

Speaker 1:

So was the goal to try to replace sovereign paper currencies such as dollars or yen or Euro or pound.

Speaker 2:

There are a number and hundreds of digital currencies that are being used currently, none of which are backed by any sovereign government, but we are seeing a number of nations putting China, the U S and a consortium of other [inaudible] countries that are trying to develop the use of blockchain technology to digitize their sovereign currency. And so over time, rather than having dollars in your wallet, you're going to have digital dollars on your mobile device that you can use and transact at the same speed as you would paper currency.

Speaker 1:

If I pay with my phone already, don't I already have digital currency? What's the difference?

Speaker 2:

If you're speaking about other digital currencies that are not backed by a sovereign country, those digital currencies are not in any way redeemed by or supported by any nation. And so the first value could fluctuate and we're seeing a number of stable coins that are backed by sovereign currency, but they don't hold the same backing

Speaker 1:

we're saying is that I can transact with people who are transacting in that particular currency, whether it's dollars or or other other types of digital currencies.

Speaker 2:

Yes.

Speaker 1:

What's the incentive for people to have multiple digital currencies as opposed to a few sovereign currencies that the value of their assets are tied to?

Speaker 2:

Currently, there is no sovereign digital currency. That could be if there was maybe more of the individuals that are using other digital currencies that are not backed by a government moving to that, but having a digital representation of an asset on blockchain allows you to transact on any blockchain infrastructure almost instantaneously. So if you think about clearance and settlement of securities transactions, you clear and settle a securities on the other end, it takes a few days for the cash to move. If you had a digital version of that cash on the same blockchain, you could have almost instantaneous clearance and settlement of any securities transaction or any other asset class

Speaker 1:

superiorly digital transactions where you've got the underlying ledger is digital and not a physical ledger at the federal reserve bank or Fort Knox or something like that. Makes transactions faster.

Speaker 2:

Yup . It makes it, makes it faster and may also cut out some of those intermediaries that slowed down that process and also that add on to the cost of clearing and settling.

Speaker 1:

That's transactions. Willie , that's all the time we have today. Thanks so much for being on the podcast. Great. Thank you, Sam, for having me today. You've been listening to the Sidley podcast. I'm Sam gaudy . Our executive producer is John the taxes. You can hear more episodes at sidley.com/sidley podcast or subscribe on Apple podcasts or wherever you get your podcasts.

Speaker 3:

[inaudible] .