Blockchain, a Facilitator of Compliance… and Accountability?
Compliance, “the action or fact of complying with a wish or command.” I really have to bite the bullet to write this one… How many times did my ex-wife remind me that I wasn’t complying with the household rules she’d unilaterally set… Freedom came on the day my attorney said,” Nick, those years of compliance are finally behind you.” Alright, it’s about Blockchain…
[Note to self: The weak can never forgive. Forgiveness is the attribute of the strong.]
One of the core benefits of Blockchain technology is immutability, which creates an environment of transparence and trustworthiness. In other words, as soon as a data is stored in the chain, it cannot be changed or deleted, which provides stakeholders with traceability. Thus, Blockchain’s immutability can be utilized to keep track of all the steps that are required to reach a certain outcome, such as a transaction or even a piece of regulation, ultimately providing any party involved with an indisputable audit trail.
At first sight, Blockchain seems to be a great tool for compliance. Is that so? And can we say the same for accountability?
Blockchain and Compliance
All industries out there need to abide by strict sets of rules, which all stem from regulatory policies. Regulators oversee operations that are conducted among parties within the boundaries of a given ecosystem. For example, in the United States there are three federal agencies that regulate mergers and acquisitions: The Securities and Exchange Commission (SEC), the Federal Trade Commission (FTC) and the Department of Justice (DOJ). These three administrations make their decisions based on several laws and regulations, including the Sherman Antitrust Act of 1890. Yes, that’s from the 19th century… Now given that one of Blockchain’s major upsides is the elimination of intermediaries, I have been asking myself the following question: Are regulators intrinsic elements inside the computation in which the organizations they oversee are engaged, or do they solely intervene in the final stage of the process to judge the feasibility and legality of a transaction?
If the former, this disposition fits the structure of a Blockchain architecture. It means the regulator needs to have its own node to access in real-time (along with all the other parties involved) the data that will ultimately trigger and then execute a smart contract as soon as this same data is in accordance with the regulator’s requirements, themselves stored inside the Blockchain. Thus, every single piece of regulation must be included inside the code of the smart contract that lies in the Blockchain network that connects all the stakeholders to one another. As a result, the regulator becomes some form of a passive actor in the process, the smart contract fully automating its function and streamlining its responsibilities.
In contrast, if the regulator solely intervenes in the final stage of the process, which is basically the modality today, a Blockchain network becomes at the very best underused, if not unnecessary. For example, imagine for a second that institutional investors transact via smart contracts on a Blockchain network. If the SEC doesn’t have its own node in this peer-to-peer network, it signifies that all data inherent to a transaction must be duplicated and pulled out of the network before being stored inside a cloud (a centralized system highly prone to hacking), so the regulator can access the information and potentially flag those operations that fall outside the realms of what’s legal. Such a process is utterly inefficient. Had the SEC its own node, then transactions between institutional investors would go through, only if they satisfied the regulator’s terms inserted inside the code of a smart contract. Would that prevent insider trading? Likely not, since there is information that cannot be digitized. Lastly and still using the same example, imagine that the SEC is now out of the picture, and institutional investors transact directly with one another in a true peer-to-peer setting, which is after all the core aspect of a Blockchain network. Would this system be governed by the law of the jungle? Would investors start functioning as a cartel? Now the elimination of an intermediary becomes an ethical issue that goes against the DNA of the Blockchain technology.
To conclude on this point, Blockchain doesn’t automatically mean compliance. However, a Blockchain network can facilitate the need for compliance in transactions, if and only if the regulator is an intrinsic part of the network.
Now, if we reduce the terms “compliance” to the sole responsibility two parties who transact via a Blockchain network have, then yes, a smart contract not only facilitates compliance between participants, but it especially enforces it. In both theory and practice, all parties have initially agreed upon the terms that are laid out inside the code of the smart contract.
Blockchain and Accountability
If Blockchain enforces compliance via the execution of smart contracts whose terms have been agreed upon by all stakeholders, doesn’t it infer that this technology also enforces accountability? If I base the discussion on the premise that individuals seek accountability and that people want to know who is responsible for certain actions and who is accountable for the consequences of those actions, then the level of traceability and transparency a Blockchain network offers is appropriate, because it fills this role. If I base the discussion on the premise that one’s level of moral responsibility is positively correlated to one’s level of accountability, then the data stored inside a Blockchain network may certainly enlighten participants on one another’s level of moral responsibility. In concrete terms, it signifies that transactions with potential partners who are quantified inside the network as “less morally responsible” won’t be executed or maybe the terms of payments will change according to the payor’s “good standing” status as recorded inside a block in the chain.
Imagine a Blockchain network, where the Standard & Poor’s and Moody's have their own node. Picture credit rating bureaus like Experian and Equifax having their own node. Reflect on the possibility of B2B suppliers and other e-commerce dinosaurs such as Amazon having their own node. Then what? An individual wants to buy a car at credit via a public Blockchain platform. Today, the credit history that car dealerships run to qualify candidates for financing returns the credit score on the day it is requested, along with a list of the potential borrower's patterns pertaining to the repayment of debts in the last seven years. What if this individual had to file for personal bankruptcy fifteen years ago? Would this information be recorded in the Blockchain and, as a result, prevent a smart contract from being triggered and then executed? Would a lack of accountability based on the repayment of debt that happened in the past still come to haunt this individual not only today but also in the future, each time he or she wants to purchase a good at credit? In other words, who would set the rules? Who would decide that the last seven years aren’t pertinent any longer? What about businesses? Past mismanagement has led many companies to become unsolvable and to restructure their debt, even though today a new management is healthy and operations are booming. But what if the data recorded in the blockchain didn’t make any distinction between both eras and came to penalize this organization, each time it intends to conduct business?
Blockchain, Compliance and Accountability
In this blog post, I’ve been asking very down-to-earth questions, and I am totally fine with the exercise, simply because new technologies often times mean infringement and abuse in all spheres of life because there is (at least initially) no clear rules. And rules are set by regulators. And regulators are intermediaries. And Blockchain aims at eliminating the intervention of third-parties. So, we’re in the presence of a can of worms that can’t wait to be opened.
Where does it stop? Or rather, where does it start? What depth in terms of historical data will be stored inside Blockchain nodes? The latter won’t matter for transactions that require outright payments. However, as soon as credit is involved, the process will certainly change. Blockchain technology as we see it today is a true game changer. But if today’s intermediaries are about to become tomorrow’s participants to a Blockchain network, simply because any other choice would have made them obsolete, the Blockchain runs the risk of being a pale duplication of the systems in place today.