Competition Law Implications Of Blockchain Technology
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This briefing examines how blockchain technology and its applications may present competition law risks that need to be properly assessed and addressed. This briefing provides key definitions, a description of how blockchain technologies work, an overview of new uses for blockchain technology, and an examination of the possible risks under the Antimonopoly Law of the People’s Republic of China (the “AML”), and the Hong Kong Competition Ordinance.
Discussions of blockchain technology typically use specialised terminology that is important to understand. A number of key terms that are useful to understand for the purposes of this article are:
- Blockchain: In simplest terms, a blockchain is a data file made up of ‘blocks’ of information (e.g. transaction data). This train of transactions is almost impossible to amend after a new ‘block’ has been added. As put by Nick Szabo (one of the founders of blockchain technology), this is like the process of a fly being suspended in amber – over time the fly is still visible, but more and more layers of amber are added. This data file (sometimes called a “distributed ledger”) is securely stored across multiple ‘nodes’ which allow for the verification of new blocks without a centralised authority able to independently control any part of the process. The entire blockchain itself contains a record of every transaction ever completed in the blockchain system (e.g. with Bitcoin or Ethereum, a complete record of every completed transaction using these currencies).
- Blocks: Each block is made up of records of any transactions (currency transfers, contracts, etc.), and identifying information about the block. This identifying information includes references to the fingerprints of earlier blocks, and a fingerprint of the block based on the one-way encryption of the transaction data it contains. Each block has a single ‘parent’, and is organized chronologically, so there is a traceable ‘chain’ back to the first block of the blockchain.
- Nodes: These are the computers connected to the blockchain network that validate and relay transactions (i.e. the hardware behind the blockchain network). The Nodes play an important role in creating individual blocks out of transaction data (one block can hold information about multiple transactions), putting the blocks in chronological order, and storing the blockchain itself.
- Private Key: Private Keys are large numbers unique to each user in the Blockchain. Each time a user wants to confirm a transaction, their Private Key is used to verify the transaction, and prevent the transaction from being changed by any other users.
- Bitcoin: A digital currency created in 2009, which is one of the earliest and most well-known applications of blockchain technology in the real world.
- Ethereum: Sometimes called ‘bitcoin 2.0’, this is a newer digital currency which also allows for computer code to be added to the currency in each block of the blockchain. This means that Ethereum allows Smart Contracts and Distributed Applications (“ĐApps”) to be integrated as part of the blockchain.
- Smart Contracts: Smart Contracts are contracts that use computer code to give effect to legal terms, to automatically verify that a set of conditions has been met, and to execute the contract. For example, a supply contract could be designed so that when the GPS coordinates of the goods match a pre-defined set of coordinates, the supplier is automatically paid for the goods delivered.
- Distributed Applications (ĐApps): ĐApps are basically software applications run on multiple computer systems simultaneously. Instead of running the entire application on a single computer, ĐApps are run on cloud computing platforms, and split up the tasks needed to run the application across the network. Simple examples of this process outside of the blockchain would include the internet, global banking systems, and GPS – none of which are centrally controlled.
- Public Chains: A fully public blockchain is one where anyone connected to the blockchain can see all the information contained in the blockchain, and participate in the verification process for each new block.
- Private Chains: A fully private blockchain, by contrast, would restrict verification of new blocks to a single node, or a limited group of nodes. A Private Chain may also have restrictions on who is able to read the information in the chain, and allow the consortium or the company running the Private Chain to change the rules of the chain, and reverse transactions, etc.
How does blockchain technology work?
Blockchain technology effectively works by creating a chain of data, like an accounting ledger, distributed across multiple nodes. Each node has a full copy of this accounting ledger and amendments need to be made by individual nodes which are then verified collectively.
In the context of blockchain currencies such as Bitcoin, when party A tries to send Bitcoin to party B, party A will use their Private Key to ‘sign’ a message containing: (i) party A’s Bitcoin address, (ii) the transaction amount, and (iii) party B’s Bitcoin address. These inputs are run through a one-way encryption algorithm which produces unique ‘fingerprint’ for the block. This message is sent from party A to a node to be added to a block and verified by each of the nodes in the Bitcoin network.
The verification process involves nodes in the network re-running the encryption of the transaction message based on the transaction inputs. If more than 50% of the nodes (in Bitcoin, calculated by computing power used to run the blockchain) on the network run the encryption and arrive at the same unique output, then the block (and the transactions it contains) is deemed verified. Once the block is verified, it is packaged into a block and added to the blockchain. The blockchain will then show party B as the owner of the Bitcoins sent by part A.
What can blockchain technology be used for?
There are a wide range of applications for blockchain technology across various industries, and this range of applications is constantly evolving.
The security of blockchain systems and the self-verification of the chain via the blockchain’s nodes are of particular interest to financial institutions. These features are especially relevant in the context of cross-border payments and on the trading floor, as they can help to reduce the time needed for clearing and settling trades (which can take several days). Relying on the self-verifying nature of blockchain transactions, trade execution, clearance and settlement could be performed by the same system without the need for trusted third parties to act as middlemen. Especially for algorithmic trading, the entire transaction could be completed in a matter of minutes instead of days.
The use of Smart Contracts in conjunction with blockchain technology may also have a significant impact on financial institutions and other businesses. Especially in industries that typically rely on standard form contracts, the use of Smart Contracts based on predetermined inputs (e.g. price, parties, conditions, etc.) may significantly lower transaction costs.
Current initiatives in this field have examined the use of Smart Contracts in executing options contracts, shipping contracts in supply chains (where, for example, payment of the contract is conditional on a truck or ship reaching a pre-defined set of coordinates), and insurance.
The unchangability and self-verification of blockchains are also relevant in industries that need to prove the origins of a particular set of goods or property. This would include supply chains (particularly for preserving food safety and maintaining quality standards), the ownership records of antiques and collectables, intellectual property ownership, and land registries.
One final use that is being considered is using the biometric data of users to create their unique Private Key. This would create a digital ID card that can be used to verify the identity of individuals seeking to access services or pay for goods. This use of blockchain technology has been incorporated into voting (e.g. to verify voter registration), and is currently being explored as a way to provide legal identification to millions of refugees, and to tackle human trafficking.
What are the potential competition law risks associated with blockchain technology?
The transformative nature of blockchain technology has raised many potential regulatory issues. These issues range from the legal enforceability of Smart Contracts to anti-money laundering concerns, securities regulations to privacy issues. For the purposes of this briefing, we will focus on a number of key competition law concerns.
One of the key issues with blockchain technology is the information-sharing aspect of the blockchain system. Once information is written into the chain, it can be accessed by any of the nodes that operate the system. Indeed, where the nodes are required to verify each block, they need to be able to access the raw inputs to run the one-way encryption.
Where transaction information is transparent, this may be used by competing firms to coordinate and fix prices, which would violate Arts. 13 and 14 of the AML, or be a concerted practice in violation of the First Conduct Rule (“FCR”) in Hong Kong.
Especially in a Private Chain operated or accessible by competing undertakings with significant market power, it is important to restrict the visibility of transaction records. Sensitive information such as trading volumes, contract terms, pricing data, and party names in these chains should not be automatically shared with every user or node. One current example of a blockchain with an anonymization feature is ‘Zcash’, which can shield the identity of the sender and the recipient, and the value of the transaction on the Zcash blockchain.
A separate issue with regards to cartel activity relates to the use of Smart Contracts and ĐApps on the blockchain. Where undertakings work together to automate the setting of prices through the use of Smart Contracts and ĐApps, they should avoid using this code to facilitate price-fixing or to manipulate prices.1
Abuse of Dominance
A number of special considerations apply under competition law to undertakings with a dominant position in a given market. Where blockchain technology is used in the context of a supply chain, a refusal by manufacturers to supply downstream consumers without access to the blockchain could constitute a refusal to supply.
Similarly, there may be exclusive dealing concerns where a limited Private Chain only allows purchasers to buy goods from the dominant undertaking. Either of these acts could potentially constitute violations under Art. 17, AML and the Second Conduct Rule (“SCR”).
In terms of pricing, a manufacturer or supplier using Smart Contracts or ĐApps to set minimum resale prices could also be at risk of Resale Price Maintenance for the purpose of Art. 17, AML and/or the SCR.
In public, transparent blockchains, the visibility of transaction data may also enable the detection of anti-competitive conduct. A law enforcement agency with access to the blockchain could simply review previous transactions in the chain for patterns of suspicious activity. The transparency and immutability of transactions on the blockchain have therefore prompted some to refer to the technology as ‘prosecution futures’. This was the case in the prosecution of Ross Ulbricht, accused of running the ‘Silk Road’ (an online black market website involved in the sale of drugs and other illegal activities). The Silk Road relied, in part, on the anonymity of bitcoin, as there were no identification requirements for opening a bitcoin wallet. However, once prosecutors were able to tie Ulbricht to his bitcoin wallet, the blockchain provided a perfect record of all the transactions his account was involved in. Ulbricht was eventually sentenced to life imprisonment in 2015.
In a Private Chain, it is less likely that law enforcement or third parties will have the chance to access the full chain on their own accord. A Private Chain used by a secretive cartel would be difficult to detect. However, the impact that a leniency application by a cartel member could have on the remaining members would be magnified by the submission of a copy of the blockchain.
Concentrations of undertakings (including mergers and acquisitions) are notifiable in the PRC under Arts. 20 & 21 of the AML. In Hong Kong, the Merger Rule only applies to the telecommunications sector. Note, however, that in Hong Kong the FCR would still apply to agreements with the object or effect of restricting competition in Hong Kong, which may include certain joint venture agreements.
In the context of blockchain corsortia and alliances, the approach taken by the Anti-Monopoly Bureau of the Ministry of Commerce (“MOFCOM”) has differed from that of other competition authorities. In June 2014, MOFCOM published only its second prohibition decision, which prohibited a proposed alliance between three container shipping companies, (the “P3 Alliance”).
This decision was unexpected as the merger had already been cleared by US authorities, and the European Commission confirmed it would not open investigation proceedings (on the basis that the alliance did not constitute a merger). MOFCOM specifically noted the high market share of the parties, as well as the centralization of operational and management decisions. MOFCOM’s approach was therefore to consider the P3 Alliance to be more of a joint venture, thus subject to notification requirements.
For consortia working on blockchain technologies, such as R3 (a consortium including more than 70 of the largest financial institutions), the creation of a single platform between multiple undertakings might result in notifiable transactions. Based on the P3 Alliance case, the creation of a network centre to jointly coordinate and manage the P3 network was enough to trigger notification requirements. Previous cases have shown that as long as the alliance or consortium can serve to eliminate or restrict competition in the PRC, notification would be required – even if the alliance or consortium was located entirely outside of the PRC. What is different for blockchain technologies is the distributed and automated nature of this coordination and management.
As mentioned above, the AML and Competition Ordinance may apply to blockchains operating outside of the PRC and Hong Kong respectively which have an impact on these markets. However, a separate issue may arise regarding the application of inconsistent legal principles from multiple jurisdictions to the apportionment of legal liability under a blockchain system.
For example, when dealing with an open-source blockchain platform with users and nodes located across multiple jurisdictions a number of unique questions arise:
- Who bears liability in a distributed blockchain platform?
- The developer, creator, or members?
- What if the technology is open-source and created collectively by multiple programmers?
- If a third-party algorithm creates trades and executes Smart Contracts in an anti-competitive fashion, who are the AML and Competition Ordinance going to be enforced against?
- What if the anti-competitive effects were the result of a bug in the code?
- When entering into contracts with a distributed autonomous organization (essentially, a distributed software program) connected to a blockchain (such as the DAO, used for crowdfunding), how will the courts interpret the legal status of the distributed autonomous organization itself (which may not have separate legal identity)?
Blockchain technology is currently at the forefront of innovation in multiple industries around the world. It is therefore no surprise that companies looking to remain relevant in the global economy are examining and testing potential uses for this technology. This has not gone unnoticed by regulators. Regulatory bodies around the world have started to consider the impacts of blockchain technology on the industries they oversee, as well as how they can use blockchain technology themselves. In the PRC and Hong Kong, the People’s Bank of China, and Hong Kong Monetary Authority have both started to look at the impacts of blockchain technology. Indeed, the Ministry of Industry and Information Technology and the Hong Kong Monetary Authority have both been involved in publishing papers looking at the impact of blockchain technology on their respective jurisdictions.
New technologies, however, bring with them new forms of regulatory oversight. It is not clear how exactly regulators will attempt to approach the regulatory issues raised by blockchain technologies. At this stage, we can simply flag potential issues that could have an impact on blockchain users in the future. It is important for companies looking to be early adopters of this technology to be aware of the potential regulatory risks involved, especially as governing rules for new chains are being considered. After all, if there are any transactions that breach the law, the blockchain itself will maintain an immutable record of these breaches.
1 In a 2016 UK Competition and Markets Authority (“CMA”) case, two competing online sellers (‘Trod Limited’ and ‘GB eye’) of posters implemented a price-fixing cartel through the use of automated repricing software. The CMA went on to warn software providers that they could violate competition law if they help clients to use their software to facilitate price-fixing arrangements. See: https://www.gov.uk/government/news/cma-warns-online-sellers-about-price-fixing .
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Author: Jonathon Zhou
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