Making Blockchain Real Using Regulatory Sandboxes

02 July 2018 Legaltech News Publication

Blockchain testing in sandboxes is an excellent way to test concepts and refine them through an iterative process, which can help mold the blockchain for a number of different uses.

Everyone knows that Blockchain is the underlying technology that allows cryptocurrencies to operate as described by Satoshi Nakamoto (an unknown person or persons whoever they may be) in a 2008 paper Bitcoin: A Peer-to-Peer Electronic Cash System to address the “Double-Spend” problem that plagued previous attempts to implement digital transactions.

But everyone does not know that in the digital economy a new testing ground for blockchain innovation is the use of “regulatory sandboxes,” which in the FinTech (financial technology) world to allow emerging business models to be tested. For example, in 2015 the Financial Conduct Authority (FCA) started in the UK and now is the “conduct regulator for 58,000 financial services firms and financial markets in the UK and the prudential regulator for over 18,000 of those firms.”

According to the Industry Sandbox, regulatory sandboxes create:

…a safe space where a FinTech and a limited number of real consumers can engage in an “on-market” trial. Some of the regulatory requirements can be amended to create a bespoke framework for the duration of the trial where the normal regulatory consequences do not apply.

Otherwise, more broadly industry sandboxes aim to create:

…a space for FinTechs and industry players to collaborate on new products and proof of concepts in an “off-market” environment without consumers. There are no regulatory implications from testing off-market, so creating a bespoke regulatory framework is not necessary. The sandbox environment can be used to simulate consumer behaviour to test and trial applications to a functional acceptance level desired by the organisation using the sandbox

Obviously, blockchain testing in sandboxes is an excellent way to test concepts and refine them through an iterative process redefining aspects with user feedback.

Arizona’s Regulatory Sandbox

In April 2018, Arizona established a Regulatory Sandbox program under the autopsies of the attorney general, which allows applicants to participate for 24 months to test its innovative financial product or service, but with restrictions on how much money can be loaned and transmitted. Each participant has to demonstrate to the state they have adequate capitalization, risk management, and management oversight with limits on the number of consumers of 17,500.

Arizona participants are not exempt for federal laws, even though the Arizona Regulatory Sandbox laws only apply to Arizona residents.

Where is Blockchain Headed?

Many governments around the world have determined that cryptocurrencies are commodities and taxable, and how those government rulings impacts other forms of blockchain remains to be determined. Now, the Bank of China, Bank of England, and the Royal Bank of Canada, to name a few, are developing blockchain monetary systems to help stabilize currency exchanges within the more traditional banking world. As a matter of fact, the Royal Bank of Canada is teaming with IBM to use blockchain and Watson for Artificial Intelligence (AI), a.k.a. Machine Learning.

Blockchain appears to be an interesting solution to allow patients to store their own patient health information (PHI), as regulated by the Health Insurance Portability and Accountability Act of 1996 (HIPAA), in secured blockchains so that the PHI is portable and when patients go from doctor to doctor, or hospital to hospital, that the patient has a complete record rather than having to gather data from each doctor or hospital.

In 2017, the U.S. Food & Drug Administration (FDA) signed a contract with IBM to use Blockchain and Watson for AI. Does that sound familiar?

Blockchain’s immutable transaction capabilities make it a valuable tool for the real estate industry since historical real property deed records can easily be locked into blocks. Improving and accelerating property searches and enabling efficient (and faster) financing transactions are only two of the anticipated uses of the technology.

Immutability and validation make blockchain an obvious solution to cybersecurity challenges like identification and authentication. With an effective and binding authentication technology, Blockchain has uses from internal, corporate identification, media streaming, credit history, and the potential for online voting. Anywhere that a secure transaction history is necessary, blockchain has capabilities.

It seems very likely that major ERP (enterprise resource planning) database systems such as Oracle, SQL, or SAP will migrate to Blockchain as a means of locking data for improved security, reducing the necessity of hosting customized databases, and maybe controlling accounting records better. We all know that every business has a responsibility to manage its accounting books and records and also publically traded companies have additional legal duties, so it does seem reasonable that blockchain could help improve the vitality of accounting data.

One major downside for users of Blockchain ERP systems is that it will be more difficult and maybe cost-prohibitive for customers to have customized ERP systems, and blockchain ERP systems are likely to be more standardized for specific industries. This is pure speculation in 2018, but time will tell.

Conclusions about Blockchain

Clearly the use of the Internet will never decrease, which impacts all businesses around the world, so it logical that laws related to the Internet will continue to have to adapt to Internet based business. As well given the overwhelming news media exposure of cryptocurrencies and increased use of Internet-based businesses, it seems likely that blockchain will continue to grow in applications around the world. As a result, sandboxes, both regulatory and industry, are practical tools to test new blockchain uses.

Blockchain has also become a marketing buzzword. It seems that every vendor or solution that uses a database is selling blockchain. In many cases, blockchain is not necessary, or even advisable, for database solutions. While blockchain is a viable technical advance, its uses are still immature and developing.

Reprinted with permission from the July 2, 2018 issue of Legaltech News. ©2018 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved.