When people hear the word “blockchain,” they usually think of cryptocurrencies such as bitcoin, which run on a blockchain platform. But the technology has far more extensive applications than generating bitcoin.
That has prompted Austin Mills, a Morris Manning & Martin associate, to start a blockchain-specific practice for the firm to advise on the unique legal issues arising from the disruptive, fast-proliferating new technology.
Mills said Morris Manning has a dozen blockchain clients—about half in Atlanta—who have built non-currency-based applications in industries ranging from health care, insurance, real estate, and financial services to event ticketing, sharing economy and digital asset management.
“The next generation is moving past cryptocurrency,” he said.
While a number of local firms have payments and financial technologies practices, Mills thinks this is the first blockchain-oriented practice for an Atlanta law firm.
A few firms in tech hot spots, such as Seattle’s Perkins Coie and Palo Alto’s Cooley, also have dedicated blockchain groups, which draw on areas of law such as securities, tax, corporate, technology, cybersecurity and payments.
“Blockchain technology is now a tangible reality that could disrupt any industry that relies on the movement of data or value,” Mills said. “A lot of people are talking about this as a paradigm shift on par with the internet.”
The idea is that blockchain-based applications can replace the Internet intermediaries that store data, transfer mortgage titles and the like. Blockchain operates using a “smart contract”—essentially an agreement that enforces itself via code rather than courts—and many adherents think blockchain technology could replace traditional contracts and payment systems used in industries like law and real estate.
The unique feature of a blockchain-enabled enterprise, Mills said, is that it takes out the “trusted intermediary,” such as a bank, that ordinarily organizes and secures a digitized marketplace.
“If you jump past the technology, the biggest thing is really the disintermediation,” he said.
Blockchain is a digital ledger that uses complex algorithms (cryptography) to process and verify transactions. Each user’s identity and transaction activity is encrypted with a unique digital key, but the digital trail of each transaction is publicly recorded and open to verification.
A blockchain operates on a distributed computing platform, so it can’t be easily modified, and it contains a complete history of activity, which proponents say makes it more difficult for fraud to occur in transactions.
“We take it for granted that businesses make money off acting as trusted intermediaries in services they provide to others, whether banks, Google or Facebook,” Mills said.
Blockchain has the potential to disrupt any online business or industry managed by a central gatekeeper, he said, because the distributed computing platform allows the activity of the users to create and maintain the market.
“It allows consumers to recapture the value they’re driving to intermediaries. Facebook is worth billions because of the ad revenue that it makes. With a blockchain-based application, all that ad revenue can be returned to the users,” Mills said.
In the social media space, there are already blockchain versions of Reddit, such as Steemit, where participants get paid for posting.
“Steemit is the same as Reddit—although not nearly as clean or polished yet—except the ad revenue fed into the system gets paid out to users on the other end,” Mills explained. “Why use Reddit if you could use blockchain Reddit and get paid $5 to $10 every month—or more if you’re a heavy user?”
In the gig economy space, Mills said, a plethora of ride-sharing entities, such as Arcade City, which bills itself as “ride-sharing for the people,” are springing up to compete with Uber, and the riders and drivers capture the extra value.
From Payments to Blockchain
Mills, 32, said he has been practicing at the intersection of fintech and payments since 2010, when he graduated from law school at George Mason University.
Atlanta has long been a hub for the payments industry, which processes card transactions, and that has evolved into fintech. Mills joined the tech transactions team at Morris Manning and started working with payments companies such as InComm and BitPay, one of the largest bitcoin payment processors. Both are based in Atlanta.
“The fintech payments industry was a starting point,” Mills said. The first blockchain was created to support bitcoin, and its early use cases were currency and payments applications.
“Everyone’s been talking in the bitcoin space—it’s a small community—about how bitcoin is one small use case and all the other things this technology could be used to do,” he said. “For the last five years though, it’s been just talk.”
The launch of another blockchain platform, Ethereum, two years ago, Mills said, “made it more practical for developers to build on top of blockchain for broader use.”
Like the bitcoin blockchain, Ethereum offers a cryptocurrency token, called ether, that can be used as an exchange unit within the system.
“A lot happening now in blockchain has little to do with payments,” Mills said.
An array of entrepreneurs have built applications on the Ethereum blockchain and hundreds are raising capital through what are called token sales, or initial coin offerings (ICOs). Individuals purchase tokens specific to the enterprise using either bitcoin or ether, and the capital raised funds the platform’s development.
In the last nine months, Mills said, ICOs “have exploded,” with at least four raising more than $100 million.
According to ICO Alert, a website that tracks token offerings, there are ICOs pending for enterprises as varied as a decentralized Uber-clone (Cryder); green energy trading (WePower); crowdsourced athlete talent management (TokenStars–“the first platform to tokenize people”); Duber, an information and advertising review exchange “transforming the cannabis industry—and for skeptics, Useless Ethereum Token.
As with fintech, the existing regulations for blockchain-based enterprises lag far behind the technology and the marketplace. Mills said the ICOs present unique legal issues, particularly around tax and regulation.
In the short term, Mills’ practice is focused on providing regulatory guidance, particularly in connection with token sales through ICOs. “We paper those sales, provide the legal documentation and structure them in a way that minimizes the tax burden, avoids violations of securities laws, and keeps them legally compliant,” he said.
The SEC currently does not regulate ICOs because the companies are not selling equity as in a traditional initial public offering (IPO) of securities. Instead, the virtual tokens that are sold generally offer pre-paid access to a service on the platform.
“You’re not giving up equity—you’re giving up a portion of the product,” Mills said. “It has the look and feel of equity—but there are big differences.”
The tokens are the only way people in the particular marketplace can transact with each other, and most blockchain enterprises cap the number available, which means, like bitcoin, they have the potential to increase in value.
SEC, IRS Are Watching
But the Securities and Exchange Commission is taking notice. It issued its first U.S. securities law guidance for ICOs on July 25, warning investors that an ICO lacks the investor protections of an IPO and in some cases could be subject to federal securities law.
“Fraudsters may entice investors by touting an ICO investment ‘opportunity’ as a way to get into this cutting-edge space, promising or guaranteeing high investment returns,” the SEC warned.
Virtual currency exchanges and other blockchain entities “may be susceptible to fraud, technical glitches, hacks, or malware,” it added. “Virtual tokens or virtual currency may be stolen by hackers.”
While companies can use ICOs to raise capital without the regulatory constraints of an IPO, the IRS considers that money taxable income—unlike in a securities offering—because it considers tokens and other cryptocurrencies as property that generates revenue when sold.
“You’ve just raised money to build something, but it’s not from selling equity—and now you’re paying income tax,” Mills said, adding that many blockchain-based enterprises are located in tax havens such as the British Virgin Islands for that reason.
As blockchain enterprises develop, the smart contract technology will raise more legal issues, Mills said. A smart contract, he explained, is an automated contract that is “100 percent legal code, not a traditional legal document.”
An obvious use is to create contract code that automatically makes a payment when a condition is met, he said, adding that the agreements that can be automated will get more complex over time.
“Demand is going to be driven by clients, not by law firms, once they realize that it’s a better solution than a paper contract—having to pull it off the shelf and dust it off, or constantly nagging a customer for payment,” he said.