It’s no secret that cryptocurrencies are plagued with scepticism. Such scepticism has only increased as a result of FTX’s ‘freefall’ into bankruptcy two weeks ago. In my view, however, that does not mean commercial lawyers should care any less about crypto. If anything, they should probably care more, given the likelihood that the FTX debacle spawns varied and complex regulations which firms can help clients negotiate. In this article, I explain how cryptocurrencies work and give three reasons why, regardless of such scandals, commercial lawyers should care about them. First and foremost, however, I provide a number of examples of venerable financial institutions embracing cryptocurrencies.
A change of heart?
Five years ago, Jamie Dimon, CEO of JPMorgan since 2005, described cryptocurrencies such as bitcoin as a ‘fraud’, only useful to those involved in criminal dealings. Indeed, Dimon, is (or perhaps more aptly was) such a crypto sceptic that he threatened to ‘fire [any trader] in a second’ if he caught them trading in crypto. Despite this, JPMorgan seems to have reconsidered, becoming the first major US bank to offer cryptocurrencies as an investment option for clients within the purview of JPMorgan’s wealth management division in 2019. More recently, the bank took on Aaron Iovine, a former executive at the now bankrupt crypto lender Celsius, as JPMorgan’s new executive director for digital assets (i.e. crypto, non-fungible tokens, etc) regulatory policy. It’s fair to say that Dimon might just have had a change of heart.
JPMorgan isn’t the only one waking up to crypto either. Recently, the Monetary Authority of Singapore gave the cryptocurrency exchange operator Coinbase the green light to offer cryptocurrency services. Coinbase is the largest cryptocurrency exchange in the US, and this international debut will surely be one to follow. This comes even in the wake of the central bank promising to be “brutal and unrelentingly hard” on regulation surrounding cryptocurrencies under the Singaporean Payment Services Act 2019. The 2019 Act regulates both internal and cross-border transactions, firmly placing it on the radar of commercial law firms looking to prove their metal in FinTech. Firms that are already established in FinTech such as Allen & Overy (ranked Band 1 by Chambers for their UK FinTech services) are likely to want to establish themselves as major players in this growing international market.
Indeed, like any financial instrument, commercial lawyers will play key roles in navigating the complex regulation that cryptocurrencies will inevitably inspire. Furthermore, the underlying technology behind cryptocurrencies could provide law firms with key opportunities to improve their legal tech offerings. Before getting to the reasons why cryptocurrencies are important to law firms, however, we should first understand just how they work.
How do cryptocurrencies work?
Essential to understanding why cryptocurrencies are so interesting requires an understanding of how they work. Like their name suggests, unlike ordinary currencies, cryptocurrencies are entirely digital. They generally operate on a system known as the ‘blockchain’, which simply reflects to a chain of different ‘blocks’ of data joined in chronological order - much like how links in a chain are connected. This forms the digital database on which information about the coin is stored, and shared peer-to-peer between every participant.
This feature is important for two reasons. First, it provides security: for a new block to be added, each peer can be checked and compared to see if the block should be there. If less than 50% of the peers on the network agree that the block should fit into the chain in that way, the attempt to modify the chain is rejected. Second, it means that the currency is decentralised. Blockchains are not just limited to cryptocurrency, as we will explore later, but this is their primary application. Once information is added to the blockchain it cannot (easily) be edited or changed. Transactions on the chain are thus securely recorded and viewable to anyone with access to the chain.
Cryptocurrencies themselves are generated by a process called ‘mining’, which is simply the use of computer power to solve increasingly complex mathematical problems. This is important for validating the chain and transactions on it, and thus a coin is awarded as a reward by the creator. Without this process of validation, it would be possible to ‘double-spend’ (i.e. spend the same coin more than once) and is therefore essential for the currency to work. As the chain grows, the puzzles solved become more and more complex and thus more computational power is needed. Eventually, the puzzles become so complex they simply cannot be solved any longer (or it is so costly to solve them in energy and parts that it is no longer commercially viable to do so). This provides an effective cap on how many coins can exist in total.
Why should law firms care about cryptocurrencies?
There are three key reasons why commercial law firms will be interested in cryptocurrencies and the associated blockchain technology.
First, cryptocurrencies are an example of a non-fiat currency. Non-fiat currencies are currencies backed by a commodity or some other mechanism of providing a hard limit on how much of the currency can exist at any given time, for example commodities such as gold. Therefore, stability in their value is brought about due to their scarcity. Conversely, fiat currencies such as the US dollar rely on confidence in their respective lender to hold value. If confidence in that lender falls, so does the value of the currency. One notable example of this happening recently was the mini budget released by Kwasi Kwarteng under the Truss premiership, where the pound hit an all-time low against the dollar. Cryptocurrencies are therefore a key asset for investors looking to diversify their portfolio against government-sponsored uncertainty.
This does not mean cryptocurrencies are immune to market scepticism. Indeed, the value of cryptocurrencies is heavily affected by the perceived value they have to their traders (as evidenced by the wildly varying prices of Bitcoin). This value will likely plateau out when cryptocurrency markets become more stabilised, and therefore they will eventually play a key role in developing a diversified portfolio that can withstand market changes. Commercial law firms should be interested in cryptocurrencies therefore as their clients are very likely to be. This is especially true now “financial services royalty” such as JPMorgan have started seriously operating within the crypto sphere.
Second, cryptocurrencies represent an invaluable opportunity for commercial law firms to foster long term client relationships. Regulation surrounding cryptocurrency is inevitably complex, and indeed developing very quickly. Some jurisdictions, such as Australia, have developed comprehensive procedures (for example cryptocurrencies being required to register with ‘AUSTRAC’, who are responsible for ‘preventing, detecting and responding to criminal abuse of the financial system’). Other jurisdictions, such as Brazil, have not developed any specific regulations for cryptocurrency, despite their acceptance by the federal government. Closer to home, the Law Commission recently published a consultation paper that suggests these sorts of digital assets could become the third category of personal property – marking a monumental change in the law. For crypto firms looking to expand internationally, navigating the complex and varied legislation presents a significant challenge, and one in which law firms will play a key role. Indeed, because these regulations must adapt so regularly to keep up with changes in the technology, law firms who establish themselves as go-to advisors on cryptocurrency legislation will likely be able to foster very lucrative and long-term relationships.
The third reason commercial law firms should care about cryptocurrencies is less related to the currency themselves than their underlying technology. Indeed, blockchain technology is pivotal to the concept of ‘smart contracts’, which (as helpfully defined by IBM) are digital contracts stored on a blockchain that are automatically executed when predetermined terms and conditions are met. To develop a smart contract, a series of if/when statements are written in code which, when verified, complete the contract by fulfilling the provision. For example, it could release funds to the appropriate party or register a special purpose vehicle with Companies House. Smart contracts could play a key role therefore in streamlining complex transactions (particularly in the insurance market, according to the European Insurance and Occupational Pensions Authority), reducing the notoriously tedious work of junior fee earners in collating signatures and documents. In an ideal world, this would open more time for law firms to provide more comprehensive training or allow their juniors to take on more intellectually stimulating matters.
Of course, smart contracts are very much still in their alpha testing period. For one, security and privacy issues have arisen. For example, in 2016 the $60m dollar attack on the Ethereum-backed Decentralised Autonomous Organisation highlighted a key re-entrancy vulnerability in that specific smart contract. Until these security issues are firmly ironed out, key financial players will be reluctant to get involved. Furthermore, the immutable nature of blockchain technology could lead to concerns with data protection regulation that includes rights to be forgotten. Most notably, this is a key provision in Article 17 of the European General Data Protection Regulation (‘GDPR’). The decentralised, peer-to-peer nature of these blockchain based contracts may make compliance here exceptionally difficult. When faced with a growing number of clients interested in these kinds of contracts, commercial law firms that can crack these issues first will be well placed to capitalise on this growing market.
Crypto is controversial, and both law firms and clients should remain cautious. However, once cracked, cryptocurrency and blockchain technology could provide several key opportunities to revolutionise the legal market by providing more diverse portfolios, giving opportunities for long-term client relationships through regulatory advice, and enabling law firms themselves to innovate. Certainly, law firms that develop an expertise in this technology first will be well placed to capitalise on the growing international demand for it.