Papers associated with Bitcoin and related topics in law: Part VII

This article was first published on Dr. Craig Wright’s blog, and we republished with permission from the author. Read Part 1, Part 2, Part 3, Part 4, Part 5, and Part 6.

The recent collapse of FTX demonstrates the need for oversight within financial accounting systems. Unfortunately, the term decentralization has been used to confuse regulators and cover up many financial crimes (Walch, 2017). Creating a methodology to explain and describe Bitcoin and link it to accounting and reporting systems will aid businesses. Blockchain technology presents various possible benefits for businesses, including the provision of a system that will provide a source of validating information and reducing accounting fraud (Bonsón & Bednárová, 2019). Yet, the process will require the development of definitions in terms that regulators and auditors can understand and that fit within the technical framework of the system.

Presently, the term decentralization is used extensively and with conflicting meanings (Walch, 2018). For blockchain technology to become part of existing accounting and reporting systems, it must shed its deceptive terminology and embrace the concept of regulation and law. Doing so requires that the description of the system and the problems associated with the misrepresentation of node connectivity be corrected and that the system is described in a way that allows regulators to monitor and maintain control over such systems.

Annotated Bibliography

Bonsón, E., & Bednárová, M. (2019). Blockchain and its implications for accounting and auditing. Meditari Accountancy Research, 27(5), 725–740. https://doi.org/10.1108/MEDAR-11-2018-0406

The authors define “Blockchain [as] a distributed digital ledger that is used to record and share information through a peer-to-peer network” (Bonsón & Bednárová, 2019, p. 725). Yet, the terminology associated with such terms has not been adequately described. Peer-to-peer (P2P) references the ability to directly connect and exchange information between users. Yet, the reference to P2P networking has documented the erroneous idea of a peer connecting to another peer through a mesh network. Such a structure has been promoted, but fails to describe the implementation of blockchain-based systems such as Bitcoin (Javarone & Wright, 2018).

The authors reference the immutability of a blockchain system. Here, they note how the alteration of a record would require changing a previous transaction in a block that has been created and that it would be impossible because of the decentralized nature of the technology (Bonsón & Bednárová, 2019, p. 726). Yet, such thinking overlooks the methodologies used within accounting systems to update and change records. For example, in accounting processes using paper-based records, the immutability of the existing records requires the addition of external journals that may link to the main general ledger. Such a structure is feasible within any blockchain network, and the implementation would ensure that the system remains immutable and records the complete transaction journal capturing all changes.

Bonsón & Bednárová provide an example of the benefits of reducing economic uncertainty (2019, p. 729). In addition, the ability to reduce agency costs and share information openly, in a way that reduces asymmetry, provides economic benefits to many organizations. The biggest benefit can be argued to derive from the increased transparency and auditability (2019, p. 730) that will come from a single verifiable source of accounting information that cannot be altered without leaving an audit trail of the alterations. Yet, the authors also argue that the limitations of scalability associated with a blockchain-based system (2019, p. 732) limit the benefits that may be attributable to a business. But, in demonstrating the interconnectivity and the transaction rate of the primary systems within the blockchain network, it will be possible to document how the system can scale, providing all such benefits.

Slabykh, I. (2019). The New Approaches to Digital Anti-Piracy in the Entertainment Industry. UIC Review of Intellectual Property Law, 19(1), [i]-99.

Slabykh (2019) has explored the P2P copyright cases of LimeWire and Grokster and how they are continuing to change digital anti-piracy within the entertainment industry. While the paper does not directly address the concept of decentralization in blockchain networks, the author documents the legal cases that have been made against peer-to-peer filesharing applications and the approach taken by the court in dealing with associated breaches. While the term decentralization has been used in arguments presenting Bitcoin as “censorship resistant” (Han et al., 2022), they have overlooked the previous approach courts took when dealing with peer-to-peer systems.

Importantly, the approach used to protect copyright and associated intellectual property rights may be utilized in ensuring the regulation and integrity of financial networks and those providing essential services. For example, the ability to limit access to domains and impose restrictions upon the distribution of files and services may equally be applied to distributions over a blockchain, as it was applied against systems such as Grokster. In addition, the lawsuits filed by digital media companies against filesharing companies such as Grokster (Hogberg, 2006) demonstrate how the judicial doctrines of vicarious liability and contributory infringement allow the courts to impose restrictions on actions taken by the users of a peer-to-peer network.

In holding users of a system liable, including corporations that deploy peer-to-peer systems, the courts can bind them and restrict access to such networks where illicit activity or financial crimes have occurred. In recent examples of impropriety, such as the FTX “cryptocurrency” exchange collapse, the extension of judicial doctrines concerning contributory infringement would enable the courts to ensure that commercial node operators involved with providing services using a blockchain act within the existing legal frameworks. Such regulations ensure that decentralized servers can come under regulatory control, as long as the system is understood and the measurement of the key centrality points in the network is completed (Bader & Madduri, 2006).

Fiat, A., Karlin, A., Koutsoupias, E., & Papadimitriou, C. (2019). Energy Equilibria in Proof-of-Work Mining. Proceedings of the 2019 ACM Conference on Economics and Computation, 489–502. https://doi.org/10.1145/3328526.3329630

Fiat et al. (2019) contend that a significant inefficiency is associated with the creation of blocks within systems such as Bitcoin. The authors note that the energy consumption is excessive and the cost of processing a transaction utilises extensive amounts of electricity; such an analysis makes an assumption that is predicated on the attribution of ideas that are distinctly different from the original promoted in the Bitcoin white paper (C. S. Wright, 2008). Specifically, the authors are assuming the requirement that many nodes operate and the terminology for decentralization applies not to the users of the system, but rather to the nodes.

The analysis and use of the term decentralization in this grouping node operation also falsely associate the concept referred to as ‘selfish mining,’ one separate from Bitcoin, with the ability to undermine the system. Such analysis has been demonstrated to be flawed (Wright, 2017). Yet, the same concept is promoted by those seeking to argue for the decentralization of nodes within Bitcoin, and the implementation of changes within Bitcoin and related blockchain systems. Each of these arguments is predicated on the inability of law enforcement to act against agents and nodes operating on a blockchain system. Yet, as can be seen in arguments by Slabykh (2019), the legal consequences of acting in a manner that damages the system lead to both direct and indirect liability.

In seeking to argue that the security function of Bitcoin is derived from the proof-of-work algorithm, the paper ignores the economic and legal aspects of the system. The authors thereby base their argument on the assumption that legal action cannot be taken against a globally distributed network or that a breach of rules and action outside the protocol cannot be used in seeking legal redress. The description of decentralization follows the treacherous path noted by Walch (2017, 2019). In presenting an argument that a blockchain network acts outside of the law, the authors neglect the legal doctrines of vicarious liability and fail to understand the economic security function presented by any blockchain system.

Additional References

Bader, D. A., & Madduri, K. (2006). Parallel algorithms for evaluating centrality indices in real-world networks. 2006 International Conference on Parallel Processing (ICPP’06), 539–550.
Bonsón, E., & Bednárová, M. (2019). Blockchain and its implications for accounting and auditing. Meditari Accountancy Research, 27(5), 725–740. https://doi.org/10.1108/MEDAR-11-2018-0406
Fiat, A., Karlin, A., Koutsoupias, E., & Papadimitriou, C. (2019). Energy Equilibria in Proof-of-Work Mining. Proceedings of the 2019 ACM Conference on Economics and Computation, 489–502. https://doi.org/10.1145/3328526.3329630
Han, Y., Xu, D., Gao, J., & Zhu, L. (2022). Using Blockchains for Censorship-Resistant Bootstrapping in Anonymity Networks. In C. Alcaraz, L. Chen, S. Li, & P. Samarati (Eds.), Information and Communications Security (pp. 240–260). Springer International Publishing. https://doi.org/10.1007/978-3-031-15777-6_14
Hogberg, S. K. (2006). The Search for Intent-Based Doctrines of Secondary Liability in Copyright Law Note. Columbia Law Review, 106(4), 909–958.
Javarone, M. A., & Wright, C. S. (2018). From Bitcoin to Bitcoin Cash: A network analysis. Proceedings of the 1st Workshop on Cryptocurrencies and Blockchains for Distributed Systems, 77–81. https://doi.org/10.1145/3211933.3211947
Slabykh, I. (2019). The New Approaches to Digital Anti-Piracy in the Entertainment Industry. UIC Review of Intellectual Property Law, 19(1), [i]-99.
Walch, A. (2017). Blockchain’s Treacherous Vocabulary: One More Challenge for Regulators. 9.
Walch, A. (2018). Deconstructing ‘Decentralization’: Exploring the Core Claim of Crypto Systems. Institute for International Economic Law at Georgetown Law School on Nov, 5, 8.
Walch, A. (2019). In code (rs) we trust: Software developers as fiduciaries in public blockchains.
Wright, C. S. (2008). Bitcoin: A Peer-to-Peer Electronic Cash System. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.3440802
Wright, D. C. S. (2017). The Fallacy of the Selfish Miner in Bitcoin: An Economic Critique (SSRN Scholarly Paper No. 3151923). https://doi.org/10.2139/ssrn.3151923

This article was lightly edited for clarity purposes.

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