Essential Corporate News: Week ending December 3, 2021
On November 26, 2021 the Financial Conduct Authority (FCA) published Policy Statement PS21/16, summarising feedback to a Consultation Paper (CP21/25) it published in July 2021
The world of finance faces huge disruption if the current interest in cryptocurrencies leads to mainstream adoption. The market capitalization of cryptocurrencies has soared since 2008 to well over US$500 billion. This interest in the decentralization of currencies and the use of blockchain technology has created new opportunities but also raises important, commercial, administrative and regulatory questions. It also raises questions about how future cryptocurrency disputes are to be resolved in a world where privacy is paramount.
In this article we explore the nature of cryptocurrencies before turning to the potential disputes likely to arise within the cryptocurrency universe and explore how arbitration may be well suited to the resolution of these disputes.
A cryptocurrency is a digital currency which relies on encryption for security and to verify transactions, and operates independently of any bank (i.e. has a decentralized control).
At its simplest, cryptocurrencies are just records of transactions (blockchains) kept on a decentralized ledger/database which all members have access to, and which is updated whenever a new transaction is verified by a consensus mechanism. When we speak of a consensus mechanism we simply mean that decisions affecting the ledger (e.g. in relation to the next block in the chain) are made by a consensus of the users of that blockchain. Some blockchains allow not only simple transfers but also more complex arrangements that automate transfers of cryptocurrency on the occurrence of specified triggers — these are referred to as “smart contracts.”
In proper use, such blockchains are theoretically immutable, meaning that it is impossible to alter existing data without detection. A single shared ledger of transactions is important for verifying the ownership of an asset or the completion of a transaction.
Cryptocurrencies also involve a degree of pseudonymity. Users use a digital, blockchain wallet to manage and hold cryptocurrencies, with each wallet tied to one or more specific keys or addresses, as opposed to names and proper identities.
The cryptocurrency market is very dynamic. However, there is no unified inter‑governmental approach to the regulation of cryptocurrencies, and with national law makers and regulators racing to keep abreast of break‑neck developments within the market, the risks for unwary investors remain significant.
Potential areas of dispute risk for those involved in cryptocurrency transactions include commercial disputes over transfers of cryptocurrency or the operation of smart contracts. However, given the pseudonymity of the market, there is also a heightened risk of fraud and the potential for violating sanction regimes, money laundering laws and terrorist financing regulations. There are also concerns for the security of the market infrastructure associated with cryptocurrencies which may yet prove susceptible to hacking.
Our recently released white paper on blockchain dispute resolution entitled Unlocking the Blockchain analyzes in more detail the risks associated with blockchain technologies such as cryptocurrencies.
With the aforementioned risks in mind it is important for investors to have access to quick, effective and affordable dispute resolution to assist them with the broad range of potential issues they may encounter in conducting transactions in cryptocurrencies. One form of dispute resolution that is inherently well‑suited to the resolution of cryptocurrency disputes, at least at the commercial level, is international arbitration.
Party autonomy, confidentiality and the ability for parties to choose arbitrators with specific expertise lie at the heart of arbitration. It therefore supports the anonymity that underpins the cryptocurrency market. It also allows parties to appoint arbitrators with the expertise necessary for the resolution of disputes which may well be both technically challenging and concern novel legal issues.
Arbitration is also more removed from the sometimes anti‑cryptocurrency rhetoric and policy objectives of regulators and, potentially, national courts. This will be appreciated by many investors in the cryptocurrency market who, at the risk of overgeneralizing, are more anti‑establishment than those invested in traditional financial models. As a neutral forum of dispute resolution, crypto‑currency investors are therefore likely to have more confidence in the arbitration process than traditional, centralized court systems.
The benefits of global enforcement of arbitral awards (under the New York Convention on the Enforcement of Foreign Arbitral Awards) are also worth bearing in mind, given the fundamentally borderless nature of blockchain technology. That said it remains to be seen how arbitral awards may be enforced against a blockchain given its decentralized nature and that transactions are verified by a consensus mechanism — the traditional means of enforcing awards by attachment of monetary assets do not necessarily apply.
The inherent flexibility of arbitration also suggests that it will be favored by cryptocurrency investors. Arbitration also affords parties greater control over how proceedings are managed. This includes control, by agreement, over if or to what extent document disclosure is necessary, the scope of evidence and whether oral evidence and hearings need to take place. The recent move of arbitral institutions to establish expedited and emergency procedures, which will improve procedural economy and led to greater cost savings, may also lead to growth in this area. Parties also have control over the format of proceedings, and therefore the increasing use of technology in arbitration will have an impact. In particular, the rise of online dispute resolution (ODR) will change how arbitration is conducted. Parties are free to agree, for example, to electronic hearings conducted over video‑link using real‑time transcription and online bundles (please see our article on Online Dispute Resolution and electronic hearings). Progress in virtual reality technologies is also likely to impact how arbitration proceedings are conducted in the future. It is entirely foreseeable that future disputes could be resolved by dedicated “cyberspace tribunals” akin to the “cyberspace courts” recently unveiled in Hangzhou.
The best international arbitral institutions have done much over the last decade to improve arbitration and to offer greater procedural flexibility. This includes by updating their standard rules and model clauses and through the emergency of specialist arbitral rules and the constitution and promotion of specialist arbitrator panels. Cryptocurrency is an area ripe for similar development — the unique nature of cryptocurrency, and cryptocurrency transactions, suggests that specialist arbitral rules and panels may soon develop. In short, watch this space.
Recent decisions by the Court of Justice of the European Union (CJEU), the EU’s top court, have abolished the rights that EU investors previously had to bring claims against EU member states in international arbitration.
© Norton Rose Fulbright LLP 2021