"The Blockchain Is Real" Understanding blockchain and its role in global supply networks

By now, bitcoin has become a household word. The idea of a digital, unregulated “cryptocurrency” elicits strong responses. Some have heralded bitcoin as revolutionary. Others, such as JPMorgan Chase CEO Jamie Dimon, denounced it as a “fraud.” But in January of this year, Dimon walked that comment back, and declared, “The blockchain is real.” Why the change?

In essence, Dimon was arguing that, despite his misgivings about digital currencies, the technology behind them? — <the blockchain> — is an actual (if less heralded) game changer for businesses. His comment underscores a crucial truth about bitcoin?:? that it represents a single “use case” amid a much larger and rapidly emerging ecosystem. Indeed, JPMorgan Chase has been a key proponent of blockchain’s operational potential in financial transactions.

This article explores what blockchain technology is, and how it is influencing global supply networks.

What is blockchain?

The blockchain is a ledger containing certain attributes that make it attractive for doing business in a digital world.

Unlike most existing ledgers, a blockchain ledger is distributed and shared across a network. There is only one ledger and, thus, only a single source of reliable information. In the world of blockchain, there are no “trusted third parties” or intermediaries such as a bank or a broker. Instead, the network participants themselves essentially police the system and verify transactions through a process called consensus.

The mechanics of the consensus process vary depending on the application. In the bitcoin example, the system is public and the requirements for verification are more onerous. In other use cases, where the network may be private, the verification process may be less demanding.

In each case, the blockchain is designed to reward truth and transparency. Hijacking the blockchain is not easy, because a majority of participants would have to conspire to provide false information. Because the ledger is distributed and shared by an unlimited network of users, there is even greater visibility and auditability.

It’s not perfect, but over time there is a snowball effect made possible by the scalability of massive digital networks. Once a series of transactions is committed to a block, the creation of new blocks depends on the accuracy of the previous blocks. That process is repeated ad infinitum. In that way, the resulting “blockchain” is said to be virtually immutable and incorruptible.

What are blockchain’s advantages?

The advantages of a blockchain include speed, cost savings, data security, and privacy, among others. Because the blockchain eliminates the need for multiple, competing ledgers, there is no need for expensive and time-consuming reconciliation.

The absence of trusted third parties also reduces settlement costs. Gone are the days where each intermediary expects a “cut” for facilitating a transaction. Instead, the system is largely self-sustaining, and the ability to transfer information and even execute simplified contracts is unconstrained by traditional barriers.

The fact that the blockchain ledger is distributed and shared by a limitless network of users makes the underlying data less vulnerable because there is no central “honey pot” of information. While it might be possible in theory to alter one copy of the blockchain ledger, the likelihood that a bad actor could alter <most> copies of the distributed ledger is virtually nonexistent.

Finally, advances in digital cryptography make it possible to conceal certain data on the blockchain depending on the specific needs of the network.

How is blockchain technology influencing global supply networks?

If all of this sounds rarefied and speculative, it’s not. In fact, blockchain’s influence on global supply networks is already yesterday’s news. While these efforts may have received less media attention than bitcoin’s recent gyrations, the long-term disruptive effect may be even greater than any cryptocurrency. As IBM’s Manav Gupta explains:

Supply chains are prime examples of blockchain’s potential for transformation that spans industries. Initial blockchain efforts could have quick impact by transforming even a small portion of the supply chain, such as the information used during importing. If import terminals received data from bills of lading earlier in the process, terminals could plan and execute more efficiently and without privacy concerns. Blockchain technology could make appropriate data visible in near real-time (for example, the departure time and weight of containers) without sharing information about the owners or value of the cargo. Costly delays and losses due to missing paperwork could be avoided.

Examples of blockchain’s global supply chain use cases include the following:

  • In April of 2018, Samsung announced that it was considering the use of blockchain technology to cut its supply chain costs by nearly 20 percent. Among the cited benefits were reduced documentation costs for container shipments and better coordination with port authorities.
  • Walmart recently partnered with IBM to create a blockchain-based system for identifying and removing recalled foods. Walmart has stated that the time needed to find tracking information for particular foods was reduced from almost 7 days to 2.2 seconds using blockchain technologies.
  • IBM’s TrustChain has been touted as a blockchain-based solution for tracing the origin of diamonds, “from mine to consumer.”
  • Similarly, a company called Provenance has successfully deployed blockchain technology to verify social sustainability claims in global food chains. In that pilot study, the company announced it was possible to trace the provenance of fish originating in southeast Asia.
  • A company called AXA has developed a blockchain-based platform for flight delay insurance. While the product is designed for consumers, the same principles could easily be applied to mitigate supply chain risks.

Next steps for franchisors and suppliers?

Blockchain is more than just bitcoin and digital currencies. As the above examples illustrate, blockchain offers a universal platform for services. Expect to see widespread adoption as businesses harness the power of blockchain to make their supply chains faster and more reliable.

To enjoy the current and long-term benefits of a more efficient, sustainable, and dependable supply chain that reduces the ultimate costs of the finished product while maintaining high performance and quality levels, companies will need to assess their  needs and appetite for risk in an evolving and necessarily changing environment. Key points for consideration include the following:

1. Jurisdiction

Blockchain has the ability to cross jurisdictional boundaries as the nodes on a blockchain can be located anywhere in the world. This poses complex jurisdictional issues requiring careful consideration in relation to the relevant contractual relationships. The principles of contract and title differ across jurisdictions; therefore, identifying the appropriate governing law is essential, and, in a decentralized environment, identifying the appropriate set of rules to apply will be challenging. Every transaction could potentially fall under the jurisdiction(s) of the location of each node in the network. This could result in the blockchain needing to be compliant with an unwieldy number of legal and regulatory regimes. In the event a fraudulent or erroneous transaction is made, pinpointing its location within the blockchain also would be challenging.

2. Service levels and performance

The willingness of vendors to commit to performance assurances is likely to be inconsistent, with vendors preferring to offer the technology and service on an almost “as is” basis, with limited service levels, and excluding warranties regarding performance. The balance of performance risk will therefore be a key metric in determining blockchain’s use.

3. Liability

The risk to customers of a systemic issue with the blockchain could be material if trades are not settled or are settled incorrectly. Likewise, the risk relating to security and confidentiality will be front and center. In case of a private blockchain, the lack of control on the functioning of the platform does not apply — but whether or not this would be sufficient to trigger the liability of the company managing the platform has not yet been tested. So the allocation and attribution of risk and liability in relation to a malfunctioning blockchain service must be considered carefully, and not just at the vendor-customer level.

4. Intellectual property

There is inevitable value in the blockchain, and ownership of the underlying intellectual property will likely form an important consideration, notwithstanding limitations on the patentability of software and business processes. Blockchain users will have to determine their IP strategy as vendors will likely want to capitalize on any other commercial benefits to be generated from the blockchain, including commercialization of the underlying data. These points will need to be carefully negotiated.

Also, a vendor or a customer may insist on ownership of IP developments, or may only be willing to “merely” license them for the term of the agreement (or perpetually if usable with other networks). In other instances, vendor restrictions on use may be acceptable. No matter the approach, there appears to be a realization that technology will have to be sourced openly in order for value to be gained.

5. Data privacy

Once data is stored in a blockchain it cannot be easily changed. This has serious implications for data privacy, especially where the relevant data is personal data or metadata sufficient to reveal personal information. Transparency of transactions on the blockchain is not easily compatible with privacy needs, thus technology-based solutions now being developed will need to be considered, including limiting who can join the blockchain — i.e., trusted nodes — and encrypting the underlying data.

6. Decentralized Autonomous Organizations (DAOs)

DAOs are essentially online, digital entities that operate through pre-coded rules, requiring minimal input. DAOs are used to execute smart contracts, recording activity on the blockchain. Modern legal systems are designed for participation by actual people — i.e., people have the power to enter into legal contracts, to sue, and to be sued. But the legal status of a DAO makes that difficult to assess since the DAO’s “management” is conducted automatically. Courts and regulators are unlikely to allow the wholesale adoption of technology that bypasses established legal norms. Thus, use of DAOs will require additional legal and policy considerations.

7. The enforceability of smart contracts

Blockchain makes possible the use of so-called “smart contracts” which are blockchain- based contracts automatically executed upon certain specified criteria coded into the contract. In theory, execution in a blockchain network eliminates the need for intermediary parties to confirm the transaction, leading to self-executing agreements. This raises significant legal questions as to the applicable regulation and, therefore, legal enforceability of smart contracts.

This is particularly true where smart contracts are built on “permissionless” blockchains, allowing for no central controlling authority. Since the point of permissionless blockchains is to decentralize authority, they might not provide for an arbitrator to resolve any disputes that arise over a contract that is executed automatically. It also remains unclear whether basic contract legal elements such as capacity and apparent or ostensible authority would apply. Also at issue is how concepts of offer and acceptance, certainty, and consideration work in this environment. Growing acceptance of electronic contracts in many countries and jurisdictions may also facilitate the adoption of smart contracts. Meanwhile, customers will need to ensure that smart contracts include appropriate dispute resolution provisions.

8. Compliance with financial services regulation

Many sourcing arrangements, including the use of certain technology solutions, require regulated entities to include in the relevant contracts a series of provisions enabling them to exert control, and seek to achieve operational continuity in relation to the services to which the contracts relate. With blockchain this may well be more of a challenge.

9. Exit

The need for exit assistance will be determined in large part by the specific solution and the extent to which the blockchain vendor holds the customer’s data. If the customer does not have its own copy of the data, it will require data migration assistance to ensure that the vendor is obliged to hand over all such data upon expiration or earlier termination of the agreement, and a complete record of all transactions stored on the blockchain.

10. Data on a blockchain

Compilations of data may be protected by intellectual property rights. Where a database of personal information is sold, a buyer seeking to “repurpose” the underlying data may be required to obtain consent from the individuals involved in order to comply with applicable privacy and data protection laws.

11. Due diligence on blockchain

Public and private investors have already begun to make significant capital investments in blockchain technology startups. This trend is likely to accelerate as adoption of blockchain technology becomes more widespread. Transactional lawyers who are tasked with performing due diligence on the buy and/or sell side in connection with these investments will need to adapt more traditional due diligence approaches. This applies, for example, with respect to ownership of data residing on decentralized ledgers and to intellectual property ownership of blockchain-as-a-service offerings operating on open-source blockchain technology platforms. The assessment will also have an impact on the business value proposition of any investment.

Joyce Mazero and William Sentell are attorneys with Polsinelli PC, a law firm with more than 825 attorneys in 21 offices. Mazero, a shareholder with the firm, is co-chair of its Global Franchise and Supply Network practice. Contact her at 214-661-5521 or jmazero@polsinelli.com. Sentell focuses his practice on franchise and distribution litigation, ADR, and related corporate, regulatory, and compliance matters. Contact him at 303-583-8287 or wsentell@polsinelli.com.

Published: July 12th, 2018

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