Blockchain – the technology powering bitcoin and other digital currencies – is poised to transform countless aspects of daily life, including the way we buy and sell things, how we trace ownership, and the nature of legal agreements. As banks and governments around the world grapple with how to harness this rising disruptive force, a team of legal and banking experts is taking the first step toward developing a framework for regulating digital currencies in New Zealand and Australia.
At present, digital currencies are highly volatile and speculative, and largely operate on the economy’s fringe. But rapid technological developments are set to push them into the mainstream. Their disruptive potential is partly due to the way they allow individuals and businesses to transact payments directly – locally or across the globe – bypassing banks and other traditional intermediaries.
“We are on the cusp of radical change, and this poses challenges for lawmakers and regulators around the world,” says Associate Professor Alex Sims, head of the Business School's Department of Commercial Law. Professor Sims is leading the team tasked with developing a potential Trans-Tasman framework for the regulation of digital currencies, with the support of a $52,000 New Zealand Law Foundation grant.
“Currently, there is no law regulating digital currencies in New Zealand. However, some people have had bank accounts closed because the bank suspected they were dealing in a digital currency,” she says.
A core element of such currencies – often called "cryptocurrencies" because they rely on extremely strong cryptography – is the blockchain. Invented in 2008 with the birth of bitcoin, a blockchain is a list or digital ledger that records transactions and stores them in secure “blocks”. Each block is then “chained” to the next with a cryptographic signature. The names of parties who make the transactions never appear on the blockchain. Instead, public keys are used, allowing for confidentiality.
Copies of blockchains are stored on thousands of computers within a network. Such distributed ledgers are more secure than conventional bank accounts, as thousands of computers would need to be hacked into at the same time to change more than 50 per cent of the copies, and anomalous transactions not replicated throughout the majority of the network would be ignored or rejected. Blockchain technology also allows for “smart contracts” – contracts that are stored, verified and executed online.
Banks, credit card companies and others in the financial sector realise that the rise of the technology threatens their role as gate-keepers and intermediaries in financial transactions, says Sims.
“If cryptocurrencies become widespread, they could slash banks’ profits. Banks are keen to use blockchain technology among themselves because the benefits are massive, but they will try to limit how others use it. There is a real danger that if they get their way, the benefits of cryptocurrencies may be eroded or even lost,” she says.
“There are also risks associated with these currencies – some as yet unknown – which is why this work is important. Currently, transactions involve small sums and cannot be reversed. What happens if a consumer’s life savings are accidentally sent to the wrong person or if a person’s private key is compromised? Then there are privacy issues. How are a person’s financial details to be kept private when the information is available to those who have access to a particular blockchain?”
She adds that at the macro level, the spread of digital currencies has the potential to compromise a country's monetary policy by weakening the control its central bank has over money supply.
Sims and her co-researchers, Professor of Banking and Finance David Mayes at the Business School, and Dr Kanchana Kariyawasam of Australia’s Griffith University Business School, aim to strike a balance between the interests of regulators and blockchain users.
“The danger is that if you regulate too much, you won’t get the full benefits, but if you regulate too lightly, you could see problems such as money laundering,” says Sims.
“This is a critical first step towards streamlining the regulatory framework in the Asia-Pacific region, as well as globally. Harmonising trans-Tasman approaches will improve finance industry stability and regional infrastructure.”
The research is the first to be funded under the New Zealand Law Foundation's $2 million Information Law and Policy Project, which was established to develop law and policy around IT, data, information, artificial intelligence, and cyber security.
Watch Professor Alex Sim's video on smart contracts (5:30)