The Governance of Blockchain Financial Networks
| Date | 01 November 2017 |
| Author | Philipp Paech |
| DOI | http://doi.org/10.1111/1468-2230.12303 |
| Published date | 01 November 2017 |
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The Governance of Blockchain Financial Networks
Philipp Paech∗
Since the emergence of the virtual currency Bitcoin in 2009, a new, Internet-based way of
recording entitlements and enforcing rights has increasingly captured the interest of businesses
and governments. The technology is commonly called ‘blockchain’ and is often associated with
a closely related phenomenon, the ‘smart contract’. The market is now exploring ways of using
these concepts for financial assets, such as securities, fiat money and derivative contracts. This
article develops a conceptual framework for the governance of blockchain-based networks in
financial markets. It constructs a vision of how financial regulation and private law should set
the boundaries of this new technology in order to protect market participants and societies at
large, while at the same time allowing the necessary room for innovation.
INTRODUCTION
In this article, I will explore the regulatory and private law issues arising from
the use of blockchain networks in financial markets, including relevant issues
pertaining to the control of such networks and to the influence of the market
on their development. I refer to the entirety of these aspects as ‘governance’,
intentionally adopting a broad understanding of this term.1The analysis es-
tablishes whether and to what extent blockchain-based business models can
exist outside the regulatory and supervisory per imeter that generally applies to
financial institutions. It further investigates the role of private law within these
networks, notably in ensuring the smooth functioning of risk-based regulation
and in avoiding a risk-shift towards non-adjusting third parties. Lastly, the ar-
ticle assesses the need for cross-jurisdictional co-ordination. It is conceived as
a mapping exercise, constructing a vision of the core governance issues and
their interdependencies, thus providing the conceptual foundation for a future
governance framework.
The emergence of blockchain technology has become inextricably linked
to Bitcoin,2a ‘virtual currency’ that allows users to trade ‘bitcoins’ directly
from peer to peer without involving banks or other intermediaries.3Whereas
∗Assistant Professor of Law, London School of Economics and Political Science. I am grateful to
Jan Kleinheisterkamp, Klaus L¨
ober, Eva Micheler, Sarah Paterson and the two anonymous reviewers
for their comments on earlier drafts, to Martin Walker for inspiring discussions and to Katerina
Papapanagiotou for research assistance.
1SeeM.Bevir,Key Concepts in Governance (London; Thousand Oaks CA: Sage, 2009) 29-30.
2 G. W. Peters and E. Panayi, ‘Understanding Modern Banking Ledgers through Blockchain
Technologies: Future of Transaction Processing and Smart Contracts on the Internet of
Money’ Working Paper, 18 November 2015 at https://papers.ssrn.com/sol3/Papers.
cfm?abstract_id=2692487, 3 (unless otherwise stated, all URLs were last accessed 30 November
2016).
3 The paper that laid the foundations for Bitcoin and the blockchain technology is
S. Nakamoto, ‘Bitcoin: A Peer-to-Peer Electronic Cash System’ Working Paper, 2009 at
C2017 The Author. The Modern Law Review C2017 The Modern Law Review Limited. (2017) 80(6) MLR 1073–1110
Published by John Wiley& Sons Ltd, 9600 Garsington Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA
The Governance of Blockchain Financial Networks
Bitcoin in theory is nothing more than a unit of account, it has in practice
developed functions akin to those of money, in particular since it can be
freely exchanged against currency and is regularly used to store value.4Bitcoin
has also risen to prominence as a means of payment (over 100,000 retailers
accept bitcoins)5and as a means of speculation6beyond the circles of Internet
aficionados in the space of just a few years. It has also gained notoriety as being
susceptible to speculative bubbles, and as the object of criminal activity.7Given
these characteristics, virtual currencies have ‘a good claim of being regarded
as money’.8However, legal categorisation is unclear and a new legal category
might be needed to recognise ‘virtual choses in possession’ as a new form of
property.9
The easiest way to understand what blockchain technology stands for is to
think of it as an Internet-based database to store entitlements, of which iden-
tical copies of equal constitutive value are held by every network participant.
The database enables each participant to trade these entitlements by instructing
the database software accordingly, which will then autonomously and irre-
versibly effect the relevant changes to the network participants’ holdings (in
addition to ‘database’, the terms ‘ledger’ and ‘record’ are also used). This was
the idea originally introduced with the Bitcoin network. Later on, blockchain
networks emerged that were more flexible in terms of what could be recorded
in the database, the most important of these probably being the Ethereum net-
work, which also allows users to trade entitlements but which can, in addition,
record and autonomously run self-executable programmes, the so-called ‘smart
contracts’.10
Meanwhile, the technology has been extended further to take in ‘real’
things,11 and may soon be used for a wide range of financial assets, ie those
https://bitcoin.org/bitcoin.pdf; for a comprehensive description, see, Peters and Panayi, ibid,
2-9; for a technical but still accessible description, see E. Wall and G. Malm, ‘Using
Blockchain Technology and Smart Contracts to Create a Distributed Securities Depository’
Masters thesis, Lund University 2016 at http://lup.lub.lu.se/luur/download?func=
downloadFile&recordOId=8885750&fileOId=8885765.
4 See C. Procter, Mann on the Legal Aspect of Money (Oxford: OUP, 7th ed, 2012) 1.170-1.172.
5 A. Cuthbertson, ‘Bitcoins now accepted by 100.000 retailers worldwide’ International
Business Times 4 February 2015 at http://www.ibtimes.co.uk/bitcoin-now-accepted-by-
100000-merchants-worldwide-1486613. See also, www.coindesk.com/information/what-can-
you-buy-with-bitcoins/.
6 See N. Mancini, ‘Bitcoin: Rischi e Difficolt`
a Normative’ (2016) 35 Banca Impresa Societ`
a
131; I. Kaminska, ‘The Mt. Gox Bitcoin Bubble’ Financial Times 4 August 2016 at
https://ftalphaville.ft.com/2015/08/04/2136420/the-mt-gox-bitcoin-bubble/.
7 See Kaminska, ibid; K. Scannell, ‘Founder of Silk Road given Life in Prison’ Financial Times 29
May 2015 at www.ft.com/content/8694f87c-0646-11e5-89c1-00144feabdc0.
8 Financial Markets Law Committee, ‘Issues of legal uncertainty arising in the context of virtual
currencies’ 2016 at http://www.fmlc.org/uploads/2/6/5/8/26584807/virtual_currencies.pdf,
23 (last accessed 7 May 2017).
9ibid.
10 See https://ethereum.org; K. Werbach, ‘Trustless Trust’ Working Paper, August 2016 at
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2844409.
11 For instance diamonds (http://www.everledger.io), government services in Estonia ranging
from healthcare to electronic court procedures (https//e-estonia.com/component), crowd-
funding applications (see A. Sunnarborg, ‘Blockchain Startups Make Up 20% of Largest
Crowdfunding Projects’ Venturebeat 15 May 2016 at http://venturebeat.com/2016/05/15/
1074 C2017 The Author. The Modern Law Review C2017 The Modern Law Review Limited.
(2017) 80(6) MLR 1073–1110
Philipp Paech
assets that, unlike virtual currencies, represent a claim against another party.
With such technology, shares or bonds could be issued,12 traded and settled on
the blockchain networks, thereby replacing stock exchanges, clearing houses
and settlement systems.13 Indeed, the technology could be used to make all
kinds of payment,14 and central banks could issue fiat money in this way.15
Likewise, derivative contracts could be concluded, administered and settled
within blockchain networks.16 In this article, I refer to these and similar
emerging structures (to the exclusion of virtual currencies) as ‘blockchain
financial networks’.
The financial industry has already spent over 1.4bn USD on research into
blockchain17 as it is expecting immense benefits from moving to the new
technology; banks are hoping to save 15–20bn USD on their infrastructure
by 2022.18 At the same time, Fintech businesses are preparing to enter the
financial market with innovative blockchain-based services,19 while regulators
and legislators are considering how to accommodate the new technology.20 Ye t
blockchain-startups-make-up-20-of-largest-crowdfunding-projects/), and music royalties
(G. Howard, ‘Bitcoin for Rock stars – A Year Later’ Forbes 25 September 2015 at http://
www.forbes.com/sites/georgehoward/2015/09/25/bitcoin-for-rock-stars-a-year-later-an-
update-from-d-a-wallach-on-blockchain-and-the-arts-part-1/#cd82c6522493).
12 See G. Chavez-Dreyfuss, ‘Overstock to Issue Stock to be traded on Blockchain Platform’
Reuters 16 March 2016 at www.reuters.com/article/us-overstock-bitcoin-stocks-
idUSKCN0WI2YA; Nasdaq, ‘Nasdaq Linq enables first-ever private securities is-
suance documented with blockchain technology’ Press release, 30 December 2015 at
http://ir.nasdaq.com/releasedetail.cfm?releaseid=948326.
13 See DTCC, ‘Embracing Disruption—Tapping the Potential of Distributed Ledgers to
Improve the Post-Trade Landscape’ January 2016 at www.dtcc.com/news/2016/january/
25/blockchain-white-paper; Euroclear and Slaughter and May, ‘Blockchain
Settlement—Regulation, Innovation and Application’ November 2016 at
www.euroclear.com/en/campaigns/Blockchain-settlement-Regulation-innovation-and-
application.html; Euroclear and Oliver Wyman, ‘Blockchain in Capital Markets’ February 2010
at www.euroclear.com/en/campaigns/blockchain-in-capital-markets.html.
14 See, for example,Ripple, ‘Settlement of international wholesale payments’ at https://r ipple.com;
Circle (consumer payment services in EUR, USD, GBP) at www.circle.com/en-gb.
15 See B. Broadbent, Deputy Governor of the Bank of England, ‘Central Banks and
Digital Currencies’ Speech at London School of Economics and Political Science,
2 March 2016 at www.bankofengland.co.uk/publications/Pages/speeches/2016/886.aspx;
J. Wild, ‘Central banks explore blockchain to create digital money’ Financial Times
2 November 2016 at www.ft.com/content/f15d3ab6-750d-11e6-bf48-b372cdb1043a; A.
Sharp, ‘Bank of Canada to publish payment experiment result in coming months’
Reuters 20 November 2016 at www.reuters.com/article/canada-cenbank-blockchain-
idUSL1N1D31J5?feedType=RSS&feedName=bondsNews.
16 See L. Brain, ‘Barclay’s Smart Contract Templates’ video, London, 18 Apr il 2016 at
https://www.r3cev.com/projects/; A. Karphal, ‘Barclay’s used blockchain technology to trade
derivatives’ CNBC 19 April 2016 at www.cnbc.com/2016/04/19/barclays-used-blockchain-
tech-to-trade-derivatives.html.
17 See World Economic Forum, ‘The future of Financial Infrastructure’ August 2016 at
https://www.weforum.org/reports/the-future-of-financial-infrastructure-an-ambitious-look-
at-how-blockchain-can-reshape-financial-services/, 14.
18 See Santander, ‘Fintech 2.0—Rebooting Financial Services’ June 2016 at https://www.
finextra.com/finextra-downloads/newsdocs/the%20fintech%202%200%20paper.pdf.
19 See, for examples, n 13 above and Clearmatics (securities and derivatives settlement) at
http://www.clearmatics.com; Epiphyte (foreign exchange settlement) at http://epiphyte.com.
20 See European Parliament, Resolution of 26 May 2016 on Virtual Currencies, Doc No
P8_TA(2016)0228); Financial Conduct Authority (UK), ‘Financial Conduct Authority
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