Thinking outside the box simply means that you’re willing to consider different solutions and methods for reaching your goal or desired outcome. You want to get from point A to point B, but you don’t necessarily need or want to take the tried and true route to get there (which is inside the box). This can also mean considering some creative alternatives in terms of the goals or desired outcomes. Moving the goalposts, even a little, can have an outsized impact on the game. The phrase is often associated with the Nine-Dot Puzzle, where the box is sometimes literally drawn around the nine dots, framing a solution space, or maybe inferred as the paper on which the dots are drawn.
In a more general sense, the box is a perspective that provides a set of constraints on possible solutions. A new perspective looks beyond that set of constraints to enable innovative thinking. Thinking differently can have a powerful and positive effect on your career. As an entrepreneur, this is why you need to think outside the box: it can help you get ahead of your competition in identifying and exploiting opportunities.
Only incremental progress lies inside the box
The reasonable man adapts himself to the world; the unreasonable one persists in trying to adapt the world to himself. Therefore all progress depends on the unreasonable man. – George Bernard Shaw
Sometimes, we can get pretty stuck in our ways. We become complacent, just going through the motions, doing what we need to but no more. We’re scared to deviate from the set route and make our own paths. If everyone just accepted things the way they are, then there would never be any innovation or improvement in the world.
A lot of the time we’re not even really present in what we’re doing – we’re on auto-pilot. If Thomas Edison was complacent and figured things were good enough the way they were, light bulbs and the electricity to power them might never have been commercially developed. If he hadn’t thought outside the box, the world could (literally) be a very dim place. Identifying topics where complacency exists can identify an opportunity for unconventional thinking.
More things are variable than you may expect
Whether you believe you can do a thing or not, you are right. — Henry Ford
If you view things as unchangeable, then nothing will ever change for the better. By thinking outside the box, you are questioning the status quo. Asking how you could improve an experience, product, or service for your clients. This allows you to keep growing as a person and as an entrepreneur. Questioning the status quo can provide the new perspectives necessary for intelligent and forward-thinking decisions in business.
When first articulating a client’s problem statement, it is not uncommon to have a lot of unstated assumptions regarding unchangeable factors. Let’s face it – factors that can’t be changed or controlled are boring. In reality, many factors change with time, geography, etc. Indeed, seemingly arbitrary changes in environmental factors may be causing the clients’ difficulties. A better understanding of the clients’ problem space may enable better controls to be identified. As an example, mankind can’t control the weather. On a smaller scale, heating and air conditioning significantly improve the quality of life for millions of people. Specialized “clean rooms” enable various industrial processes (from semiconductor manufacturing to biomedical research). Just because the initial client problem description assumes some factor is unchangeable, does not mean that change and control of that factor is impossible.
Outside the box perspectives
“The task is…not so much to see what no one has yet seen; but to think what nobody has yet thought, about that which everybody sees.” ― Erwin Schrödinger
Thinking outside the box can expand your worldview, allowing you to have a greater perspective. This includes not only the events and happenings in your career but also in other dimensions in your life. When you’re willing to consider alternative points of view and ways of doing things, you’ll be more open to a variety of different points of view and potential solutions. Moving from the client’s problem to a solution is not always a straight line. Creativity is often required in developing an appropriate perspective before attempting solution innovation.
This need for a new perspective is why so many businesses bring in outside consultants to help come up with new ideas. The consultants don’t carry the burden of constraints on their thinking from existing tools and processes. Their version of Outside-The-Box Thinking can dream up and offer up wildly new ideas that get people excited and lead to innovative pivots etc.
We can help!
Framing and reframing the problem from different perspectives can enable you to see past constraints. These constraints may not exist from a different perspective. Developing a client-centric, solution-agnostic problem statement can enable the needed creative thinking. For wider variety of potential solutions to be exposed, you need a broader perspective of the clients’ problem. Our free Guide to Writing Problem Statements can help you get your client program statement right.
Whether you are a researcher, business professional, or social entrepreneur, the solutions you develop to the problems that you face matter! We’d like to hear your thinking on the most important challenges so you can think outside the box for your clients. We have a brief survey that should take less than 2 minutes of your time to complete. You can get started right away by going to this link. I look forward to sharing these insights and resources with you.
A course on the use of perspective to refine problem statements is now available.
There is an episode of the vintage TV show “I Love Lucy” where Lucy works wrapping candies on an assembly line. The candies keep coming closer together as the line speeds up. Lucy, and her sidekick Ethel, scramble harder to keep up, though they keep getting further behind. Then Lucy finally says, “I think we’re fighting a losing game”. Your business initiatives may have you feeling like that – working harder and harder to keep up rather than working smarter. In Lucy’s case, the increasing assembly line speed had some comedic value. It is no laughing matter, however, if your business initiatives are not seeing the results you need. Increasing costs (e.g. effort) and reduced value (e.g., customer traction, efficiency) are signs that it is time to change the game.
Automating a broken process (like Lucy’s) just accelerates the costs. Rather than fighting a losing game, recognize that it’s time to change the game to one that you can succeed at. Analyzing your broken process may not help if you are working on the wrong problem. In every sector and region, reshaping our world, are disruptive and innovative game-changers. These may be start-ups or larger corporates, or even social entrepreneurs. They are ambitious, stretching vision with enlightened purpose. Gamechangers see markets as kaleidoscopes of infinite possibilities, assembling and defining them to their advantage. They find their own space, then shape it in their own vision. Most of all game-changers have great ideas. They don’t believe in being slightly cheaper or slightly better. They out-think their competition. By thinking bigger and differently, game-changers are solving a different, better, problem to their competition.
Game-Changing : not just for sports
Lucy’s assembly line, and the sports arena, are not the only place game-changing plays are made. Through innovation, and strategic vision, we can change the game in business deals, in our career, in relationships, and more. In the non-profit world, “changing the game” can enable a path to relief for those that need it most. When we articulate the game we are playing, we can examine further with questions like, “what are the rules of this game?”, “how am I keeping score?” “Is this game serving the needs of my clients and myself?”
Consider this thought experiment – suppose a new entrant (e.g., a startup) is competing against an incumbent (e.g. a large company). If the new entrant decides to offer the product (or some part of it) for free, (e.g., as open-source software) and chooses to monetize its customer base through some other business model, this changes the rules of the game. Such action with a radically different business model changes customer perceptions. Thus changing the marginal return from existing competencies that the incumbent has. This reshuffles the market: winning no longer requires greater competencies along the status-quo dimension, some new competitive dimension becomes the measure that determines the winner. In this new game, the existing incumbent company might have no real advantage compared to the new entrant.
Be the game-changer you need to see
The business model is just a type of model, and may not accurately represent the needs and purposes of your business stakeholders and most importantly, your clients. All models are wrong, but some are useful, (according to George Box). What is the model surrounding your business challenge? The rules are you are playing by? Parameters you think you need to follow? What beliefs do you have about the Client’s situation? What would happen if you reversed or changed the old model’s beliefs? Is there a better foundation or structure or perspective would better serve your goals? your clients’ goals? What new perspective feels empowering? Whenever you feel stuck, see if you can’t find a new, more empowering perspective, and a bigger opportunity to serve your clients.
It’s easy to get distracted by the tools and processes in your current environment. This is especially true when you need to keep the current business running while finding a better way forward. But you won’t be thinking differently if you just focus on the same old tools and processes. Such a focus leads to merely incremental rather than disruptive innovation. To avoid such issues, a clearer statement of your client’s problem is needed before attempting to solve it. Our free Guide to Writing Problem Statements can help you get your client program statement right.
We can help you change the game
Whether you are a researcher, business professional, or social entrepreneur, the solutions you develop to the problems that you face matter! We’d like to hear your view of the most important challenges in writing problem statements for your clients. We have a brief survey on the most important challenges that should take less than 2 minutes to complete. The survey takes less than 2 minutes and you can get started right away by going to this link. I look forward to sharing these insights and resources with you.
A course on the use of perspective to refine problem statements is now available.
Technology refers to industrial, practical, or mechanical arts and applied sciences that are deployed to deliver a particular solution. The Technical Perspective provides a good, comprehensive picture of the system at an appropriate level of abstraction, appropriate for the objective of the modeling, and the size of the system being modeled.
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The Technical Perspective defines the views of the system using models, processes, and other constructs of that particular technology. The various models used by the technology show how people (or other technical entities) interact with processes at various locations within the system. These technology models recognize a limited set of other technical entities and the things they handle and use. The models also show how these different aspects and things must statically and/or dynamically relate to one another, to produce the desired results. Technology models place emphasis on the structures, conditions, and interaction of entities, roles, locations, and processes and often rely on a specific modeling language (e.g. UML, BPMN) to capture the model. Specific technologies are identified (e.g., Computational aspects, such as storage, computers, and communications), where necessary to describe a solution with specificity. A design pattern for the usage of particular technologies may also be identified or defined.
Taken together, the technical events (and rules), technical roles, technical entities, technical activities, and technical locations describe the system’s elements from a technical perspective. The technical perspective describes the process, or method, explaining how a specific result is to be achieved. The effectiveness of solutions developed from technical perspectives are often evaluated in terms of their efficiency, or resource utilization (e.g., energy consumption, throughput).
Business Perspectives
The Business Perspective defines the business level view of the problem using the resources available to the business and the tools available to the business to achieve its commercial objectives. While there are many corporate stakeholders, for most businesses, their commercial objectives include profitability from their transactions with clients or customers; efficiency in internal operations, and supplier interactions; minimization of regulatory oversight costs; and strategic positioning for advantage against competitors. The business perspective shows clients’ (and employees’) interaction with business processes and resources at various locations within the business.
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The business perspective and technical perspective can address the same problem domain at different abstraction levels. The business perspective may focus on the level of a sales process with offers, and other marketing activities to influence or build a relationship with the client, resulting in a contract, followed by service delivery, while a technical perspective may focus on more detailed technical systems and entities (e.g., messages, protocols, databases, etc.) that might implement or support a business process like a sales transaction.
A business perspective can assume a particular business model; or consider an alternative business model or business practice. A business model may be impacted by the scale of responsibility of a particular business manager. The effectiveness of solutions and decisions developed from a business perspective is usually measured with accounting metrics and market or economic statistics.
Legal Perspectives
A legal perspective is relating to or characteristic of the law or the profession of law; and analyses the problem in terms that are recognized, enforceable, or having a remedy at law rather than in equity. There are three essential components to a legal perspective – (1) the identification of the client, (2) the legal right, obligation, or risk, at issue within the circumstances of the problem and, (3) the posture of the client with respect to that legal issue (e.g., defensive vs offensive) i.e., the client’s objectives.
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The purpose and goals of the law as an instrument of public policies for society at large, provide a context for the legal perspective. Different theories of law can be used by lawyers to define, explain, compare, and distinguish the facts and circumstances of particular controversies in their clients’ favor. For lawyers in private practice, clients may be individuals or other legal entities (e.g., corporations). Lawyers in administrative or judicial government roles may be representing those governmental organizations. Focusing on their clients’ potential for legal issues and outcomes enables the legal perspective to avoid some of the concerns of other parties’ views.
The narrative of a particular problem statement or situation may involve multiple legal issues, claims, rights, obligations, or risks at issue. The nature and likelihood of legal risks to business operations or other situations can be difficult to predict with certainty at any given moment as it involves some estimation of the likelihood of events occurring and the severity of the impact should the events occur, as well as the interpretations of those events that may be constructed by others (e.g., a court).
The client’s posture (with respect to, and awareness of, particular legal issues, and possible legal remedies) may change between the moment of a particular incident and upon later reflection and other considerations. The clients’ range of acceptable goals, and the likelihood of achievement, also impacts the legal posture to be adopted.
Triangulating the Problem Statement and Innovation Potential
Framing and reframing perspectives on problems highlights the differences between different perspectives. The contrast achieved by describing a problem statement from these three different perspectives enables insight into opportunities for new innovation. A common innovation pattern is for technology innovation to enable new business services or practices which are then reinforced by reducing legal risks through experience and authoritative legal decisions that then enable further technology innovation in a reinforcing cycle. While this is a common innovation pattern, disruptive innovation is not restricted to technology. Innovations in business practices or legal concepts may also provide significant opportunities.
When developing the problem statement for your client, understanding the technical, business and legal perspectives can impact the scope of the desired future state as well as constraints on viable solutions. If you are developing client problem statements, you might be interested in our free Guide to Writing Problem Statements.
Everyone has Client’s problems that they need to solve, but are they solving the right problem? Are you solving your best problem? Whether you are a researcher, business professional or social entrepreneur, the solutions you develop to the problems that you face matter! We’d like to hear your view of the most important challenges in writing problem statements for your clients. We have a brief survey on the most important challenges that should take less than 2 minutes to complete. The survey tackles less than 2 minutes, and you can get started right away by going to this link. I look forward to sharing these insights and resources with you.
A course on the use of perspective to refine problem statements is now available.
Framing is a mental structure that is built upon the beliefs you have about yourself, your roles, your resources, your circumstances, and about other people. It is a structure you use to ascribe meaning in what you observe of the world around you. In other words, the meaning you perceive from any event is dependent upon how you frame it in your mind. As such, your frames shape how you perceive the world, yourself, and others. Our human perceptual capacity is like a magnifying glass that we can move over text or images. We focus in on something and often lose awareness of what originally surrounded that magnified area. It’s like cropping photos on our digital cameras. We crop the image to our preferred view of the scene and forget the bigger picture. Frames are inherent in your perception of the world; as such, they are either helpful within the context you are using them, or they are not. Frames can be optimistic or pessimistic, expand your possibilities or limit them (e.g. a growth or fixed mindset – (Dweck 2008)). Frames are therefore appropriate or inappropriate, good or bad, depending on your objectives. The more control you can achieve of the frame, the more options you have for selecting a frame that is more appropriate for your objectives. Framing and reframing perspectives on problem statements brings greater clarity to that problem statement.
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When you decide to work on a project with others, you frame that problem with a scope in a project statement so that everyone knows what is included and excluded. With an explicit project statement, everyone can understand what a successful project outcome is and what they need to focus on in order to complete their part of the project. In the same way, the frames you use on a daily basis provide a context for your thoughts, attitudes, decisions, and actions. They help guide the direction of your thoughts, attitudes, decisions, and actions to help you accomplish your desired outcomes. Your desired outcomes may be an internal change (e.g. in creating new habits) or an external change in the world around you. Problems have been described at the discrepancy between the current state and some desired future state (your objective). Just as a project statement guides the completion of a project, a problem statement can be used to guide the solution of a problem to achieve your objectives.
When you’re stuck on a problem it often helps to look at it from another perspective. A “fresh pair of eyes” can be all that you need to come up with a great solution. Reframing is seeing the current situation from a different perspective. Reframing can be tremendously helpful in problem solving, decision making and learning. With reframing, one shifts one’s perspective to be more empowered to act effectively and impactfully. The goal of reframing is to expand your vision of a problem’s context so that you can consider a wider range of interpretations of what’s happened (the current state), or a wider range of potential future states (the desired outcomes), or a wider range of control mechanisms to transform the current state into the desired outcomes. Many times, merely reframing one’s perspective on a situation can also help people change how they feel about the situation. Reframing enables a choice of how to frame a problem, an opportunity for empowerment through learning and decision making. Recall that some frames may be more or less helpful for achieving particular objectives. Frame selection choices may enable easier, more efficient problem resolution, and/ or greater impact or value in the achievable outcomes.
Framing and reframing perspectives on problems
Framing and reframing perspectives on problems highlights the differences between different perspectives. When we consciously reframe, we look for patterns, examine our filters, and question our perceptions, we can emerge with a new picture of reality. We can reframe by shifting the perspective in a variety of dimensions (e.g. time, people, risk, resources (input scale), results (output scale). Many problems require participation by others for solution. Truly wicked problems require significant attitude shift by large numbers of other stakeholders. If we share our new perceptions with others and hear theirs, we can shift perspective into an enlarged reality. It can create change and movement, in personal relationships, in organizations, and even society at large.
The first step in solving your problem is to define the problem with a problem statement so that you can focus on the important aspects of your problem and remove the distractions that obscure its essential features. The process of selecting the essential aspects of your problem creates a (problem solving) framework for its resolution. Even without an explicit problem-solving framework, you inherently select some subset of information about your problem. If the problem is framed in such a way that essential elements remain obscured, then this frame may not be very helpful to resolving the problem. When consciously using a Problem-Solving Framework, you explicitly identify the essential features that you want to see in your problem statement. Using and explicit frame to structure your problem statement provides a starting point. Framing and reframing perspectives on the problem statement typically proceeds by asking a series of questions from a new perspective and then recreating the problem statement based on that perspective.
Is your client’s problem sensitive to the way it is framed?
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Is your client’s problem sensitive to the way it is framed? Your client may not recognize the impact of framing the problem statement on potential problem solutions. Viable solutions may be cheaper and easier to develop if they only need to be applicable to clients within a reduced scope developed by refining the problem statement.
When developing the problem statement for your client, understanding diverse perspectives can impact the scope of the desired future state as well as constraints on viable solutions. If you are developing client problem statements, you might be interested in our free Guide to Writing Problem Statements. Everyone has Client’s problems that they need to solve, but are they solving the right problem? Are you solving your best problem? Whether you are a researcher, business professional or social entrepreneur, the solutions you develop to the problems that you face matter! We’d like to hear your view of the most important challenges in writing problem statements for your clients. We have a brief survey on the most important challenges that should take less than 2 minutes to complete. The survey tackles less than 2 minutes and you can get started right away by going to this link. I look forward to sharing these insights and resources with you.
A course on the use of perspective to refine problem statements is now available.
If you need help bringing the power of perspective to your client problem statement contact me.
References
(Dweck 2008) Dweck, C. S. (2008). Mindset: The new psychology of success. Random House Digital, Inc..
Ethics, Law and Technology Adoption
Technology is changing the world at an unprecedented pace, creating new opportunities and challenges for humanity. How do we ensure that technology is used for good and not evil? How do we regulate and govern technology in a fair and transparent way? How do we adapt and thrive in a rapidly evolving technological landscape? These are some of the questions that this blog will explore, focusing on three key areas: technology ethics, technology law, and technology adoption. In this blog, you’ll find:
Technology Ethics: This section will examine the moral and ethical implications of emerging technologies, such as blockchain, DAOs, and AI. We’ll discuss topics such as privacy, security, accountability, responsibility, and social impact of these technologies. We’ll also explore the ethical frameworks and principles that can guide us in making ethical decisions about technology.
Technology Law: This section will analyze the legal and regulatory aspects of emerging technologies, such as blockchain, DAOs, and AI. We’ll cover topics such as intellectual property, contracts, liability, compliance, and governance of these technologies. We’ll also review the current and proposed laws and regulations that affect these technologies in different jurisdictions and contexts.
Technology Adoption: This section will investigate the factors and processes that influence the adoption and diffusion of emerging technologies, such as blockchain, DAOs, and AI. We’ll look at topics such as innovation, diffusion, adoption, resistance, and acceptance of these technologies. We’ll also share best practices and tips on how to adopt and use these technologies effectively and efficiently.
By reading this blog, you’ll gain a deeper understanding of the complex and dynamic relationship between technology and society. You’ll also learn how to navigate the opportunities and challenges that technology presents in your personal and professional life. Whether you’re a tech enthusiast, a tech skeptic, or somewhere in between, this blog is for you. Join us as we explore the fascinating world of technology ethics, technology law, and technology adoption. Some recent examples of my work include books on Ethics, Law and Technology Adoptionand Blockchains, Smart Contracts and the Law as well as a Udemy course on the use of perspective to enable you to solve a better problem.
Ethics, Law, and Technology Adoption
One of the challenges in Technology adoption is ensuring that you are solving your best problem. If you are developing client problem statements to enable greater insight on creative/disruptive approaches, you might be interested in our free Guide to Writing Problem Statements, or our course: Problem Perspectives: Solve your best problem! If you need help with your problem statement contact me.
The Power of Perspective can be distinguished in multiple dimensions
Perspectives are the lenses through which we see the world whether you are a school student, business professional, social entrepreneur or concerned with your own creativity. Perspectives shape how we interpret information, solve problems, and make decisions. Perspectives can be distinguished by three factors: (i) the data they observe, (ii) the methods of processing that data, and (iii) the values attributed to the outcomes of that data processing. The Power of Perspective is that taking diverse perspectives exposes assumptions and inconsistencies, enabling better problem-solving. Consider how these dimensions of a perspective can vary between different perspectives and shed new insight into the problems you confront.
Perspective Dimenions
Explicit Data Observations exposes the Power of perspective
A specific perspective focuses on the data that it deems relevant. The selected data becomes the basis for the analysis and evaluation associated with that perspective, framing the limits of what that perspective can deliver. Selecting some data for analysis means rejecting other data, and being explicit about the data selection exposes potential blind spots. Consider how these different perspectives are constrained by the data they select.
From a scientific perspective, data is typically primary observations from carefully designed experiments.
From a technological perspective, data might include design objectives, environmental measurements, secondary data on component characteristics etc.
From a market perspective, market data may be primary observations or secondary studies concerning the need for or intended use of a new product or service.
From a regulatory perspective, secondary data on industry performance is typically collected through regulatorily required reporting.
Explicit Processing Methods demonstrate the skills associated with specific perspectives
A specific perspective may have particular skills associated with it that provide methods for processing or analyzing the data selected by that perspective. Some perspectives utilize data analysis methods that are very quantitative with some degree of implied precision, while others are more qualitative recognizing e.g. different categories of data.
From a scientific perspective, scientific methods develop models of the world which enable predictions that can be tested for validity, falsifiability etc.
From a technological perspective, design methods include industry best practices, use of scientific models, calculations of expected performance in various conditions
From a market perspective, key requirements and product concepts can be articulated and tested prior to implementation. Such testing can also be used in the estimation of expected market size, value etc.
From a regulatory perspective, economic studies, judicial outcomes and other policy considerations can be used to guide the development of policies affecting specific industries or technologies
The power of perspective is often seen best in divergent valuation approaches
Perspectives use values to gauge the results of their analysis. Values can be idiosyncratic or informed by some explicit rule to associate some meaning of “goodness” to an analytic output. For example, a two perspectives may both look at real estate sales data and conclude that there is a trend of rising prices. One perspective may interpret this as a good result because the value of that perspective holder’s real estate wealth is increasing. A different perspective may conclude this trend is a social disaster as young folks forming new households would not be able to afford to purchase a house. Consider the valuation mechanisms that these perspectives use:
From a scientific perspective, scientific progress is achieved through the dissemination and adoption by others of new models of model extensions.
From a technological perspective, successful implementations are typically evaluated in terms of the delivery of design objectives and various performance metrics such as cost or efficiency
From a market perspective, market success is usually measured in terms of market adoption and value received.
From a regulatory perspective, regulatory outcomes are typically valued in terms of alignment with policy objectives and more general social and legal concepts such as fairness
Conclusions
Perspective-taking is not only a social skill but also a cognitive skill. It enables you to see things differently, think creatively, and solve problems more effectively. Perspective-taking can also help you build rapport, trust, and loyalty with your team and stakeholders. If you are interested in taking this Power of Perspectivecourse, please visit our website for more information and registration details. Don’t miss this opportunity to unlock the Power of Perspective for yourself and your organization.
There are disparate views in the literature regarding the life cycles of contracts compared with smart contracts. [Gisler 2000] identified four phases of the legal contracting process – Information (contract conception), Intention (contract preparation), agreement (contract negotiation), settlement (contract fulfillment). The smart contract life cycle in [Sillaber 2017]’s view consists of four different phases: Creation, freezing, execution, and finalization. [ISO 2019] also considered the smart contract lifecycle, but in terms of three phases: creation, operation and termination. Note that the operation phase also included consideration of modifying smart contracts in public blockchains systems, the update and rollback mechanisms supported by the blockchain and migration mechanisms defined by smart contracts. As the more recent definition, and the result of a group consensus, let us adopt the ISO life cycle structure. Gisler’s information, intention and agreement phases would map to the smart contract creation phase of ISO; the settlement phase then being the smart contract operation. Similarly, Sillaber’s creation and freezing phases map to the smart contract creation phase of ISO; the execution phase to smart contract operation; and the finalization phase to smart contract termination.
Blockchain, or, more generally, distributed
ledger, technologies are rising in popularity because of smart contracts. Not all dapps will qualify as smart contracts,
and not all smart contracts will be legally recognizable under contract law
[Guadamuz 2019] but some portion will be. A great deal of attention is given to
the practice of development, i.e. programming, of smart contracts; [AlKahlil
2019] argues that more attention should be given to the needs of lawyers as the traditional developers of contracts. Commercial
contracts are sometimes ruefully described as “documents written by lawyers,
for lawyers,” artifacts of a negotiated exchange wrapped tightly in pages of
clauses intended to insulate the agreement against litigation attacks [Barton
2019]. It is not intuitively obvious that all
of the contractual terms for some set of contracts can be implemented in
smart contract logic (i.e., many contractual terms require some aspect of
performance by external actors in the physical world); but for some subset of
contracts, smart contract can implement the necessary terms to provide value in
automating the transaction execution. In the following sections we consider
typical smart contract life cycle operations, and whether legal roles are
necessary in those phases.
The discussion is largely based on
Ethereum as the most prevalent smart contract platform. Ethereum distinguishes
between externally owned accounts (often
called users), and smart contract
accounts. For any account, its data is stored at its address. Contracts
additionally have bytecode stored at their respective addresses. This code is
executed only when receiving a call; ie the smart contract reacts as a server (in
a client server architecture) responding to requests from other clients. Transactions are signed data packages
sent from users to other users (or smart contracts); and recorded on the
blockchain. Messages are data
packages sent from smart contracts to other smart contracts or users and are
reflected in the execution trace and potential permanent data changes.
Smart contract
creation
Business lawyers add value by
structuring the agreement during its creation [Gilson 1984]. Sometimes this may
be achieved through non-price related terms such as warranties and
indemnifications [Jastrzebski 2019]. Some of these terms may be difficult to
execute directly in the smart contract, as they often rely on performance by
other actors in the physical world. For the subset of contractual terms
implementable by smart contracts, lawyers may still need to add value for their
clients by reviewing contract proposals prior to agreement and negotiating
alternative transaction structures. Negotiation on deal structuring likely
happens prior to developing the smart contract code, as any changes negotiated
would then need to be modified, essentially requiring a new smart contract to
be created. Implementation of existing
industry standardized contracts as (parametrized) smart contracts reduces the
need for contract negotiation, leaving only the contract review aspect. A
business lawyer might review a standardized contract prior to its initial use (or
upon its revision), and then develop business guidelines on acceptable
parameter ranges given other business policies, regulatory constraints etc.
Smart contract code development
typically starts with an existing contract as the objective. Code development
and testing occur prior to deployment on the blockchain. Modern software
development approaches tend to be incremental; stressing development of verifiable
functionality first with later optimization on non-functional characteristics
like performance. While devops approaches may be applicable in a blockchain
context; continuous integration/ continuous deployment (CI/CD) approaches may
be more challenging due to the nature of the blockchain. For a smart contract to exist on the blockchain,
it needs to be created by another address via the deployment (constructor) code,
which is executed once by the EVM. A smart
contract can be created by either a user or by another smart contract [DiAngelo
2019]. Contracts become deployed as part of Ethereum’s global state by wrapping
their initialization code in a transaction, signing it and broadcasting it to
the network. The state and the code of smart contracts are publicly accessible,
enabling inspections and audits [Patsonakis 2019]. Developers typically
implement their smart contracts with the Solidity language, then build the source
code using the Solidity compiler (solc) to generate the EVM bytecode. A typical
EVM bytecode is composed of three parts: creation code, runtime code and swarm
code. Swarm code is not served for execution purpose. Solc uses the metadata of
a contract, including compiler version, source code and the located block
number, to calculate the so-called Swarm
hash, which can be used to query on Swarm (a decentralized storage system)
to prove the consistency between the contract in swarm storage and the contract
being deployed. As a result, re-deploying a smart contract would result in a
different swarm code, even with the same creation code and runtime code [He
2019]. The swarm hash can provide an indication of version changes, but does
not provide indications of the scope of the change similar to other versioning
systems (e.g., semver.org)
In practice, how a lawyer could review a smart contract
implementation for these aspects is problematic unless they have also developed
skills in the appropriate smart contract platform, programming language, etc. traditional
legal skills are helpful in distinguishing subtle ambiguities in the conceptual
agreement capturing the contract, but new skills would be required to validate
the subtleties of smart contract implementations. Several implementations of distributed
ledgers have been proposed, and different languages for the development of
smart contracts have been suggested. [AlKahlil 2019] proposed a list of
requirements for a human and machine-readable contract authoring language,
friendly to lawyers, serving as a common (and a specification) language, for
programmers, and the parties to a contract.
Operational Aspects
of Smart Contracts
The costs of computing on the blockchain are non-trivial –
estimated at two orders of magnitude greater than cloud computing, and in some
cases the blockchain design requires transaction fees. Transaction fees, which
compensate miners for their work in validating transactions, are a function of
their byte size and the complexity of the code they invoke (if any). Ethereum
employs a flat cost model, i.e., each transaction byte and EVM operation costs
some predefined amount of gas. Transactions specify a gas price, which converts
ether to gas and influences the incentive of miners to include it in their next
block. The higher the gas price, the higher its real monetary cost and priority
to be mined [Patsonakis 2019]. Transaction costs provide incentives for smart
contract designers to be efficient and minimize the operational costs of their
smart contracts. There is a tradeoff
between cost efficiency for a particular smart contract vs the development and
reuse of standardized code libraries of other smart contracts on the blockchain.
Cost awareness in the code also implies a complication at code design time by
requiring this cost awareness. Cloud computing in contrast also charges for the
execution, but this decision is made at run time, and typically out of band to
the code being executed.
In light of potentially devastating financial consequences from smart contracts, several regulatory bodies have identified a need to audit smart contracts for security and correctness guarantees [Zhou 2018]. Auditors need to be able to establish the existence, valuation and ownership of assets managed by a smart contract [Pimentel 2019]. Where the blockchain is public and software inspectable, software inspecting the blockchain is limited to the digital asset; it does not reach to any underlying physical assets. Standardized tokens may facilitate such inspections, but it remains to be seen if they are sufficient for audit and other purposes. While smart contracts could be designed to monitor the results of other smart contracts for conformance to some set of rules, it is not clear that such monitoring contracts would cover the full scope of applicable compliance, financial reporting, and other regulations. In addition, common operational performance metrics like service liveness, availability etc. remain to be standardized in the context of blockchain systems (e.g. is the existence of a smart contract in the block sufficient to determine availability of the service it offers?). Lawyers may be engaged in settlement operations (e.g. a residential real estate closing), though most of the work they perform is the document review and preparation prior to the settlement meeting event. A smart contract could automate the asset transfers on a closing statement, but this still requires the prior document review and preparation by competent professionals. In the case of smart contracts, the equivalent review and preparation is likely to be focused on the creation and inspection of the securitized tokens to assure their fitness for purpose.
Mechanisms to upgrade an existing deployed smart contract are
not obvious. Barring some disruptive hard fork of the blockchain, smart
contract code is immutably recorded in the distributed ledgers. Hence, design
patterns using smart contract registries or delegatecall() constructs have
emerged to upgrade contracts; these patterns, however, introduce problems [Harz
2018]. It is difficult, but not impossible, to provide for a smart upgrade mechanism.
[McCloskey 2019] provides an example method for upgrading a smart contract
system on Ethereum.
The blockchains underlying the smart contracts also need to
be able to upgrade. Hard forks are not unknown, even in relatively mature
blockchains. In 2017 (almost 10 years after its introduction), Bitcoin upgraded
to implement “segregated witness” (“SegWit”). Some data in transactions was
moved from one portion of the block to another in a way that effectively increased
the number of transactions that could fit in each block. The blockchain before
SegWit and the blockchain after had different semantics. It takes human actions
to upgrade blockchains and Bitcoin’s users collectively acted to modify
Bitcoin’s semantics in ways that would invalidate some transactions. A critical
mass of miners announced their support for SegWit, and then on the agreed-upon
date started enforcing the new rules; everyone else went along for the ride
[Grimmelman 2019]. Governance of blockchain upgrades varies across the different
blockchain implementations. Tezos is a self-amending crypto-ledger. The
protocol that validates blocks and implements the consensus algorithm can amend
itself. Concretely a new protocol is downloaded from the network, compiled and
how-swapped to replace the current one. In order to amend itself, Tezos uses an
on-chain voting system where users of the blockchain participate to propose,
select, adopt or reject new amendments. [Allombert 2019]. Support for contract
code upgrades and explicit reference to dispute resolution procedures can be
supported in permissioned blockchains like CORDA [Brown 2016]. Blockchain hard
forks are a potentially disruptive aspect of the operational environment that should
be considered in the design of smart contracts.
Hard forks can impact the value of assets held in the distributed
ledgers, and the operation of smart contracts deployed on the blockchain. Human
action is required to implement hard forks, typically by programmers developing
the blockchain code or operating the miners. Owners of assets impacted by a blockchain
fork may seek redress from those initiating the fork [Walch 2019]. In such
cases, these developers may also need legal services. The development of
standardized behaviors for upgrades in both smart contracts and blockchains may
help reduce such liability risks during the operating phase of the smart
contract life cycle.
Termination of smart
contract
Smart contracts are supposed to be self-executing and
terminate on completion. Ethereum’s Solidity language for smart contracts
provides a function for that purpose. A Turing complete language provides no
intrinsic guarantees that a program will terminate. There are three primary
methods [Harris 2019] to guarantee termination in smart contract programs (i) Turing Incompleteness: To avoid entering
an endless loop, a Turing Incomplete blockchain (e.g. Bitcoin) will have
limited functionality and may be incapable of making jumps and loops;(ii) Steps and Fee Meters: A smart contract
can keep track of the number “steps” it has taken and then terminate once a
step count has been reached, or with a fee meter, smart contracts are executed
with a pre-paid amount put into a reserve. Every instruction execution requires
a specified fee. The contract is subsequently terminated if the fee spent
exceeds the pre-paid allocated amount; (iii) Timers: Here a pre-determined timer is maintained; if the contract
execution exceeds the time limit then it is externally aborted. Ethereum uses
the fee meter approach for termination, requiring “gas” (a fee) to deploy and
execute smart contracts. Once the gas used exceeds the pre-paid allocated
amount, the contract is terminated.
As a result of both technical and human factors, contractual
disputes can still occur, even in automated settings. Abnormal contract
terminations are typical triggers for the contracting parties to engage their
lawyers to review their options. Abnormal smart contract terminations may be due
to a mistake of fact (e.g. the smart contract reacts to reports of some
external event that are incorrect) or mistakes in operation (e.g., the smart
contract fails to terminate, or terminates early). Reliance on detecting anomalous
transactions is too late – the transaction has already been recorded on the blockchain;
and standard methods to reverse transactions on blockchains do not exist. Termination
of a legal contact and termination of a smart contract may not perfectly coincide
in time. Consider a legal contract to transfer some physical asset to a new
owner through a smart contract. The “tokenization” of the asset must occur
prior to the termination of the smart contract. The smart contract likely
concludes on the transfer of the token. The recipient may have additional steps
to gain control of the physical asset given the token representing it. Such “detokenization”
may take some time, and possibly interaction with a third party custodian of the
physical asset.
References
[AlKahlil 2019] F. Al Khalil, et al. “Trust in
smart contracts is a process, as well.” International Conference
on Financial Cryptography and Data Security. Springer, Cham, 2017.
[Allombert 2019] V. Allombert, et. al.,
“Introduction to the Tezos Blockchain.” arXiv preprint
arXiv:1909.08458 (2019).
[Barton 2019] T. Barton,
et al. “Successful Contracts: Integrating Design and
Technology.” Legal Tech, Smart Contracts and Blockchain.
Springer, Singapore, 2019. 63-91.
[Brown 2016] R. Brown, et. al., “Corda: an introduction.” R3
CEV, August 1 (2016): 15.
[DiAngelo 2019] M. Di Angelo, & G. Salzer. “Collateral
Use of Deployment Code for Smart Contracts in Ethereum.” 2019 10th
IFIP International Conference on New Technologies, Mobility and Security (NTMS).
IEEE, 2019.
[Guadamuz 2019] A. Guadamuz, “All watched over by
machines of loving grace: A critical look at smart contracts.” Computer
Law & Security Review (2019): 105338.
[Harz 2018] D. Harz, & W. Knottenbelt.
“Towards safer smart contracts: A survey of languages and verification
methods.” arXiv preprint arXiv:1809.09805 (2018).
[ISO 2019] ISO/TC307
“Blockchain and distributed ledger technologies — Overview of and interactions
between smart contracts in blockchain and distributed ledger technology systems,”
ISO/TR 23455:2019
[Jastrzebski 2019] J. Jastrzębski, “Value
Creation in Negotiations of Contractual Warranties and
Indemnifications.” European Company and Financial Law Review 16.3
(2019): 273-309.
[Rimba 2018] P. Rimba, et. al., “Quantifying the
Cost of Distrust: Comparing Blockchain and Cloud Services for Business Process
Execution.” Information Systems Frontiers (2018): 1-19.
[Sillaber 2017] C. Sillaber, & B. Waltl.
“Life cycle of smart contracts in blockchain ecosystems.” Datenschutz
und Datensicherheit-DuD 41.8 (2017): 497-500
Bitcoins can be considered an asset or
speculative investment rather than a currency [Yermack 2013].
The tradability of Bitcoin units on specialized trading platforms has made practical
for investment professionals. The launch of Bitcoin-linked funds by global
investment banks increased the accessibility to the Bitcoin market.
Importantly, the launch of futures contracts based on Bitcoin prices in late
2017 enhanced the legitimacy of Bitcoin as an investment and moved it into the mainstream
of the financial world. Gold, and to a lesser extent, commodities, in general,
act as effective diversifiers against the downside risk in equity markets (for
both advanced and emerging economies). Investors purchase bullion with gold
futures and exchange-traded funds, and are thus exposed to the price
variation in gold, and a hedge against stock price volatility. The oil market is one of the most volatile
commodity markets. In a derivatives
marketplace, individuals and businesses everywhere are able to lock in a future
price by putting it into a binding contract. These products are called futures
and options – contractual agreements to buy or sell an amount of something at a
fixed price at a future date. When people and companies come to futures
exchanges to buy and sell commodities and financial products, what they’re
really trying to do is remove risk from their business or make money as an
investor when prices fluctuate. An investment asset which provides not
just diversification, but also a safe haven during stress periods is
particularly valuable in construction of an investment portfolio. Various market indices are used to benchmark
commodity trades. The S&P Goldman Sachs Commodity Index (GSCI), is a world
production-weighted index including 24 exchange-traded futures contract
commodities from five sectors -energy products, industrial metals, agricultural products,
agricultural and livestock products, and precious metals. This is a widely
tracked benchmark commodity index and the most liquid commodity futures index and can play the role of a
diversifier asset. It can also be used as a measure of general price movement
and inflation in the world economy. Bitcoins were the first virtual currency
and consequently much of the regulatory discussions have been framed in terms
of bitcoin, though other blockchain applications may have quite different characteristics
and uses. In the following section the terminology related to futures, options
and swaps is reviewed. The US regulatory framework for commodities is then
briefly summarized, and recognized roles in commodity markets noted. The current
US regulatory framework for commodities recognizes virtual currencies as a
commodity, enabling the issuance of futures and options on these currencies.
Some of the effects of this as a financial asset are then considered. This
article concludes with some recent controversies arising from this regulatory
treatment of crypto currencies as commodities.
Futures,
Options & Swaps Terminology
Clearing: The procedure through which a Clearing House becomes the buyer to each seller of a futures contract and the seller to each buyer. The Clearing House assumes the responsibility of ensuring that each buyer and seller performs on each contract. Futures exchanges process millions of trades each day. With so many orders coming at once, you need a lot of checkpoints to make sure everything goes smoothly.
Clearing firm: A company that works directly through an exchange’s Clearing House to execute trades on behalf of futures market participants. clearing firms check the financial strength of both parties to the trade, whether they’re a big institution or an individual trader. They also provide access to trading platforms, where the buyer and seller agree on the price, quantity, and maturity of the contract. Then, when the contract is cleared by matching these offsetting (one buy, one sell) positions together, the Clearing House guarantees that both buyer and seller get paid. This offsetting or “netting” process takes risk out of the financial system as a whole.
Clearing House: The division of a futures exchange that confirms, clears and settles all trades through an exchange. Clearing Houses act as a neutral counterparty for every single trade that crosses a futures exchange, assuming responsibility for ensuring buyer and seller performance on each contract.
Commodity: Any product approved
and designated for trading or clearing in accordance with the rules of an
exchange. Also: may refer to a physical commodity.
Counterparty: The individual or
company (i.e., the buyer or seller) on the opposite side of any trade.
Delivery: The changing of
ownership or control of a commodity once a futures contract date expires.
Derivative: A financial
instrument, such as a futures or options contract, whose value is based upon a
physical commodity or other financial instruments.
Exchange: A central
marketplace with established rules and regulations where buyers and sellers
meet to trade futures and options contracts.
Financial Future: A future contract
whose value is based upon financial instruments such as a stock index, interest
rates or foreign currency exchange rates. Generally, three types of financial
futures – foreign currency market, interest rate market, equity index market.
Future: A standardized
contract for the purchase and sale of financial instruments or physical
commodities on a futures exchange for future delivery.
Futures Exchange: A central marketplace
where buyers and sellers come together to trade futures and options contracts.
Hedge: To buy or sell a
futures contract in order to lock in the price of the underlying commodity at a
later date.
Option: A contract that gives
the bearer the right, but not the obligation, to buy or sell a futures contract
at a specified price within a specified time period.
Over-The-Counter Derivative:
Futures
and options contracts with terms that do not necessarily adhere to those of a
standardized futures contract.
Over-The-Counter Trading:
Trades
that take place outside of a formal futures exchange. OTC derivatives let
traders go beyond standardized futures products and customize the terms of the
contracts they trade. Usually, the traders work through a network of dealers
who negotiate these agreements on a one-to-one basis. Though it offers greater
freedom and potentially lower trading costs, OTC trading may leave both parties
at risk for counterparty default if
they are not using the services of a clearing house.
Self-Regulatory
Organization: (SRO) Futures exchanges and regulatory entities that set rules and
regulations and have internal functions that perform complex checks and
balances to adhere to the principles they set.
Settlement: The delivery of cash
or commodities in exchange for payment, as specified by the terms of the
underlying contract.
US
Regulatory Framework for Commodities
The Commodity
Exchange Act (1936) (CEA) provides for Federal regulation of all commodities
and futures trading activities. It requires all futures and commodity options
to be traded on organized exchanges. The CFTC was created by the Act and its
powers substantially revised in the Commodity Futures Trading Commission Act
(1974) which expanded the scope beyond listed agricultural products. The
mission of the U.S. Commodity Futures Trading Commission is to promote the
integrity, resilience, and vibrancy of the U.S. derivatives markets through
sound regulation. A trillion-dollar
market for interest rate and currency swaps emerged in the 1980s. These
transactions were similar to forward delivery futures contracts for
agricultural commodities. The Futures Trading Practices Act (1992) gave the
CFTC the power to exempt some transactions from the requirement for exchange
trading. The Commodity Futures Modernization Act (CFMA) [ CMFA 2000] modernized
regulations for over the counter (OTC) transactions between “sophisticated
parties” so these would not be regulated as “commodities” under CEA or
“securities” under federal securities laws. The definition of
“commodity” in the CEA is broad. It can mean a physical commodity, such as an
agricultural product (e.g., wheat, cotton) or natural resource (e.g., gold,
oil). It can mean a currency or interest rate. The CEA definition of
“commodity” also includes “all services, rights, and interests . . . in which
contracts for future delivery are presently or in the future dealt in.” Beyond
instances of fraud or manipulation, the CFTC generally does not oversee “spot”
or cash market exchanges and transactions involving virtual currencies that do
not utilize margin, leverage, or financing. The CFTC looks beyond form and
considers the actual substance and purpose of an activity when applying the
federal commodities laws and CFTC regulations
The CFTC’s Advisory Committees were created to provide input and make recommendations to the Commission on a variety of regulatory and market issues that affect the integrity and competitiveness of U.S. markets. The committees facilitate communication between the Commission and U.S. futures markets, trading firms, market participants, and end-users. The committees currently include:
LabCFTC is the focal point
for the CFTC’s efforts to promote responsible FinTech innovation and fair
competition for the benefit of the American public. LabCFTC is designed to make
the CFTC more accessible to FinTech innovators. It serves as a platform to
inform the Commission’s understanding of new technologies. Further, LabCFTC is
an information source for the Commission and the CFTC staff on responsible
innovation that may influence policy development. There are two major
components of LabCFTC- Guidepoint and CFTC 2.0
GuidePointaccepts a wide range of inquiries ranging from specific
registration or compliance requirements to broader questions about the CFTC’s
regulatory framework – e.g., how it may accommodate new systems,
business models, or services made possible through responsible FinTech
innovation. Within the CFTC, inquiries may be referred to the appropriate
groups and subject matter experts with the aim to ensure that any response is
both accurate and tailored to the entity’s circumstances.
CFTC
2.0 is intended to provide the agency opportunities to engage with new
technologies to discover ideas and technologies that have the potential to
improve the effectiveness and efficiency of the agency in carrying out its
day-to-day activities.
The CFTC has published a number of documents
as guidance on Cryptocurrencies:
The CFTC first found that Bitcoin and other virtual currencies are properly defined as commodities in 2015. In the Matter of: Coinflip, Inc., d/b/a Derivabit, and Francisco Riordan, CFTC Docket No. 15-29 (Section 1a(9) of the Act defines “commodity” to include, among other things, “all services, rights, and interests in which contracts for future delivery are presently or in the future dealt in.” 7 U.S.C. § 1a(9). The definition of a “commodity” is broad. See, e.g., Board of Trade of City of Chicago v. SEC, 677 F. 2d 1137, 1142 (7th Cir. 1982)). Bitcoin and other virtual currencies are encompassed in the definition and properly defined as commodities. CFTC authority to regulate virtual currency as a commodity was affirmed in CFTC v. McDonnell (2018). The CFTC has a number of other causes of action it can pursue, e.g., Price manipulation of a virtual currency traded in interstate commerce; pre-arranged or wash trading in an exchange-traded virtual currency swap or futures contract; certain schemes involving virtual currency marketed to retail customers, such as off-exchange financed commodity transactions with persons who fail to register with the CFTC. CFTC has had several successful prosecutions for ponzi schemes in the context of virtual currency (e.g., CFTC v Dean ,CFTC vs My Big Coin Pay Inc.) and for future exchanges not registered with the CFTC as a SEF or DCM (e.g., In re BXFNA Inc. d/b/a Bitfinex, Dkt. No. 16-19 ).
The National Futures Association (NFA) is the industrywide, self-regulatory organization for the U.S. derivatives industry. Designated by the CFTC as a registered futures association, NFA strives to safeguard the integrity of the derivatives markets, protect investors and ensure their members meet their regulatory responsibilities. NFA’s formal designation as a “registered futures association” was granted by the CFTC on September 22, 1981. NFA began its regulatory operations in 1982. CFTC regulations also require, with few exceptions, CFTC registered firms to be NFA Members. The CFTC has delegated registration responsibility to NFA. The NFA requires additional reporting on virtual currency transactions:
Internationally, the International Swaps and Derivatives Association (ISDA) has a similar role to NFA; reducing counterparty credit risk, increasing transparency, and improving the industry’s operational infrastructure in support of its primary goals; to build robust, stable financial markets and a strong financial regulatory framework. While not specifically focussed on cryptocurrencies, ISDA has published a number of documents related to smart contracts.
Recognized Roles in Commodity Markets
NFA Commodity Pool
Operator (CPO) A commodity pool operator (CPO) is an individual or organization
that operates a commodity pool and solicits funds for that commodity pool. A
commodity pool is an enterprise in which funds contributed by a number of
persons are combined for the purpose of trading futures contracts or options on
futures, retail off-exchange forex contracts, or swaps, or to invest in another
commodity pool.
NFA Commodity Trading
Adviser (CTA) A commodity trading advisor (CTA) is an individual or
organization that, for compensation or profit, advises others, directly or
indirectly, as to the value of or the advisability of buying or selling futures
contracts, options on futures, retail off-exchange forex contracts or swaps.
Indirect advice includes exercising trading authority over a customer’s account
or giving advice through written publications or other media.
On-exchange trading is the trading of
commodities and contracts that are listed on an exchange. Off-exchange trading,
also known as over-the-counter (OTC)
trading, is the trading of commodities, contracts or other financial
instruments that are not listed on-exchange. Off-exchange trading can occur
electronically or over the phone. Some foreign currency (forex) contracts are
traded off-exchange.
Designated Contract
Market
(DCM) – an exchange that may list for trading futures or option contracts based
on all types of commodities and that may allow access to their facilities by
all types of traders, including retail customers. Some DCMs have been operating
for many years as traditional futures exchanges, while others are new markets
that were only recently designated as contract markets by the CFTC. CFTC staff
perform regular reviews of each DCM’s ongoing compliance with the required core
principles called Rule Enforcement Reviews. CFTC maintains a List of DCMs.
Derivatives Clearing
Organization (DCO) – an entity that enables each party to an agreement, contract, or
transaction to substitute, through novation or otherwise, the credit of the DCO
for the credit of the parties; arranges or provides, on a multilateral basis,
for the settlement or netting of obligations; or otherwise provides clearing services
or arrangements that mutualize or transfer credit risk among participants. A
DCO that seeks to provide clearing services with respect to futures contracts,
options on futures contracts, or swaps must register with the CFTC before it
can begin providing such services. The CFTC maintains a List of DCOs.
Futures Commission
Merchant (FCM) – an intermediary that solicits or accepts orders for futures or
options contracts traded on or subject to the rules of an exchange; and in or
in connection with such solicitation or acceptance of orders, accepts money,
securities, or property (or extends credit in lieu thereof) to margin,
guarantee, or secure any trades or contracts that result or may result.
Introducing Broker (IB) – an
intermediary that solicits or accepts orders for futures or options contracts
traded on or subject to the rules of an exchange; and does not accept any money,
securities, or property (or extend credit in lieu thereof) to margin,
guarantee, or secure any trades or contracts that result or may result.
Swap Execution Facilities – Section 733 of the
Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”)
adopts new Section 5h of the Commodity Exchange Act (“CEA”), which provides
that no person may operate a facility for the trading or processing of swaps
unless the facility is registered as a swap execution
facility (“SEF”) or as a designated contract market (“DCM”). The
CFTC maintains a List of SEFs.
Effects of Cryptocurrency Commoditization
Several organizations (e.g., Cantor Exchange, CBOE Futures Exchange (CFE), Chicago Mercantile Exchange (CME). LedgerX, Nadex, TeraExchange) had registered with the CFTC as exchanges for Bitcoin Futures, Options or swaps. The Chicago Board Options Exchange (CBOE) has announced that it is dropping any new bitcoin futures contracts (XBT). This may have been due to low trading volumes. Bitcoin futures (BTC) are still live at CME. You can hedge Bitcoin exposure or harness its performance with a futures product. Based on the growing interest in cryptocurrencies and a strong demand for more tools to manage bitcoin exposure, CME Group plans to launch options on Bitcoin futures (BTC) in early 2020. The CME settles its contracts against an index called BRR (Bitcoin reference rate) which is an average of spot prices quoted on different exchanges. CME created a Bitcoin Reference Rate (BRR) and CME Bitcoin Real-Time Index (BRTI) as a standardized reference rate and spot price index, respectively, with independent oversight to accelerating the professionalization of bitcoin trading. CME has been generating BRR and BRTI rates since November 2016 with several bitcoin exchanges and trading platforms providing pricing data, including Bitstamp, Coinbase, itBit, Kraken, and Gemini. (See CME’s Bitcoin Reference Rate Analysis). Note that trading in Bitcoin futures doesn’t imply trading in Bitcoin itself. Bitcoin Futures Quotes are available online from the CME.
While the commodity markets for crude oil and gold are characterized by considerable short-run supply-side uncertainty (e.g., political events, surprise discoveries, and technological developments). Uncertainty of this type does not exist on the supply-side of Bitcoin. Thus, the observed price fluctuations of Bitcoin can be interpreted as demand shocks. [Ali 2014)] asserted that “digital currencies have meaning only to the extent that participants agree that they have meaning.” A change in this “meaning” due to changes in demand is not different from a demand shock in the crude oil market. Empirical analysis reveals that Bitcoin price dynamics are particularly influenced by extreme price movements. This influence is found to be larger than in the markets for crude oil and gold. Among the explanations for this is certainly the immaturity of the market [Gronwald 2019]. Cryptocurrencies have taken a further step in the direction of commodities with the emergence of cold storage [Geman 2019]. Cold storage means generating and storing the crypto coins’ private keys in an offline environment in order to avoid the online vulnerability to hacking. The most popular cold storage options are:
a) A paper wallet containing a pair of
private/public keys printed on a piece of paper, with keys generated offline
securely;
b) A hardware wallet is an electronic
device, but the most robust cold storage choice for cryptos. The three popular
options offered on the market are Ledger Nano, Trezor and Keepkey;
c) A USB drive can also be a cold wallet,
easy to obtain but with the risk that anyone having access to the USB can
access the crypto
Call options give buyers the possibility of getting a financial exposure to Bitcoin prices while puts provide the classical protection to those owning the cryptocurrency. Bitcoin futures were launched by the Chicago Board of Options Exchange and the Chicago Mercantile Exchange group on December 18th, 2017. The total market capitalization of all cryptocurrencies was 828 billion dollars in January 2018 (just after two Exchanges launched futures), 200 billion in August 2018 and 272 billion in September 2019. Note that the fraction of bitcoin in the total market capitalization was 86% in January 2017, went to 34% in January 2018 and back to 68% in September 2019. Futures trading drove up the price of Bitcoin immediately after the announcement day. This reaction started to decrease noticeably following the launch of the futures contracts. Such an outcome seems in line with the trading behavior that typically accompanies the launch of futures markets for an asset. [Bouoiyou 2019]. CME Futures are subject to significant regulatory oversight by the (CFTC), and are protected from counterparty risk by the Clearing House of the Exchange. This is a desirable feature since more than 36 cryptocurrency trading venues had closed by the end of December 2018. Moreover, they partly allow avoiding the fragmentation that sometimes prevailed in the Bitcoin spot market: during periods of high volatility, prices observed for Bitcoins on different platforms over identical time periods could diverge by more than 10%. Storability and convenience yield enables the derivation of a (valuable) spot-forward relationship. Applying the traditional options pricing mechanism of the Black-Scholes Model in this setting provides bounds on option prices [Geman 2019].
Some commodities provide diversification benefits while others may not be useful for portfolio diversification. Bitcoin adds portfolio diversification benefits above and beyond other commodities. The correlation between bitcoin and other assets is exceptionally low and the inclusion of bitcoin dramatically improves the risk-adjusted returns of the portfolios. Bitcoin’s inclusion in optimal portfolios leads to a better risk-return ratio. Bitcoin can play an important role in enhancing the efficiency of an investor’s portfolio. These findings are robust to expanding and rolling estimation windows, transaction costs, the 2018 downturn in Bitcoin, different values of risk aversion, alternative indices, as well as to alternative portfolio construction techniques and to simulated data and when short selling is permitted, although the analysis is still based on the historical mean asset returns as return forecasts and the historical return variances and covariances [Platanakis 2019]. Historical returns, however, can be poor estimates of future returns, especially given Bitcoin prices’ large volatility. The inclusion of Bitcoin (BTC) in oil, gold, and equity portfolios substantially reduced the portfolio risk. BTC and gold markets have respectively negative and weak conditional correlations with oil. The correlation between S&P GSCI and BTC as well as gold is close to zero. [Al-Yahyaee 2019]. The Dollar is a better alternative to hedge oil implied volatility (OVX) than Bitcoin. Bitcoin outperforms gold and commodity in hedging OVX. Bitcoin is a better hedge to demand-side oil shocks in comparison to the Dollar. Bitcoin hedges the demand-side shocks better that supply-side shocks [Das 2019]. This does not necessarily mean that Bitcoin is a superior asset over others to hedge oil-related uncertainties. The hedging capacity of different assets is conditional upon the nature of commodity risks and market situation. A single asset cannot hedge downside risks in different economic situations and market states. Investors may prefer different investment instruments to hedge downside risks in different economic situations and market states.
An asset is labeled a strong safe-haven if there is evidence of predictability from a stock index to that asset in the low quantiles of both the stock and the asset returns, and the sign of this predictability is negative. This ensures that extreme negative stock returns are followed by future positive returns in the (safe-haven) asset, i.e. the movement of the (safe-haven) asset in the opposite direction of that of the stock index ensures that the losses occurring in stock investments are counterbalanced. In contrast, an asset is labeled a weak safe-haven if there is no evidence of predictability from a stock index to that asset in the low quantiles of both the stock and the asset returns [Shahzad 2019]. Bitcoin, gold, and commodities have a similarity in their weak safe-haven properties for the world stock market index, which is not the case for the developed, emerging, US, and Chinese stock markets. In fact, gold is the only weak safe-haven asset in developed stock markets, whereas both gold and commodities play that role in emerging stock markets. Interestingly, Bitcoin shares with commodities the weak safe-haven property in China, whereas commodities are the only weak safe-haven asset in the US [Shahzad 2019a]. While futures on virtual currencies have facilitated trading in this asset class, regulatory ambiguity on the treatment of the underlying assets also impedes its viability as a safe haven.
With cryptocurrencies becoming more connected and more prominent within the system, the nature of information spillovers changes over time. The role of energy commodities, in contrast, is dependent on their price dynamics. Cryptocurrencies are integrated within broadly-defined commodity markets. From a theoretical point of view, different information channels and factors may play a role in forming a connection between the cryptocurrency market and the commodity markets. One correlated-information channel through which connections occur is via the price-discovery process. A second is the risk premium channel, through which a shock in one market may adversely affect the willingness of market participants to hold risk in any market. Industry-specific development may provide additional information linkages (e.g. A blockchain platform has been established to facilitate trade in crude oil between commodity firms). Potential linkages between energy and Bitcoin markets have been based on the rationale that energy, in the form of electricity, is the main cost of Bitcoin production (i.e., for mining). Commodities enjoy a strong network structure that is also intertwined with financial assets. Increasing connectedness [Ji 2019] between commodity and cryptocurrency markets weakens the attractiveness of portfolio diversification across these markets:
energy and agricultural commodities are the driving
forces of the whole commodity system.
cryptocurrencies are not detached from the system and are
more connected to the global commodity markets than are metals (including
gold).
cryptocurrencies are not strongly affected by energy
commodities, which goes against the basic idea that electricity prices form an
important part of cryptocurrency production costs.
cryptocurrencies become more connected to and more
important within the overall commodity network over time.
energy commodities become less important over time as
they are evidently connected to the price dynamics of crude oil as a representative
commodity.
the portfolio management role of cryptocurrencies as
diversifiers is not necessarily as strong as is commonly believed, at least
during times of general asset appreciation.
Controversies from the Commoditization of Cryptocurrencies
[Kogan 2019] argues that the holding in CFTC vs McDonnell is overly broad. Many virtual currencies are designed for drastically different purposes, with distinct technological protocols. The term “virtual currency” encompasses many different, independently developed applications of distributed ledger technology. Need to distinguish between virtual currencies, cryptocurrencies, tokens, digital currencies – the court used a virtual currency definition as simply a digital representation of value that exists solely online, has no government legal tender status and can be traded as a medium of exchange, a unit of account or a store of value. The agency’s regulatory authority under CEA should not include services and tokens that cannot underlay DCM transactions, but the court decision would appear to grant that authority. For example, smart contracts running on a blockchain would appear to fall within the court’s definition. The CFTC has not directly addressed how liability for Commodity Exchange Act (CEA) violations involving blockchain or distributed ledger technology should be allocated among the various parties involved in the distributed ledger network, such as the network itself, persons running consensus nodes, developers building applications on the platform, and businesses and end-users using such applications [Mathews 2019].
CFTC regulation requires that any new
contract not be readily susceptible to manipulation, but a careful review of
the record indicates that bitcoin futures are susceptible to manipulation
because the bitcoin spot market can be manipulated. In reviewing the contracts
leading up to their self-certification, [Reiners 2019] argues that the CFTC
ignored underlying dynamics in the bitcoin spot market and chose to exclusively
focus on the ability of the contracts themselves to be manipulated; doubting
that a futures contract can be resistant to manipulation when the asset
underlying the contract is readily manipulated. The price of bitcoin varies
depending on the exchange it trades on, and some exchanges have very low
volume, so CME carefully constructed a reference rate for their futures
contracts that could not be manipulated. The Securities and Exchange Commission
(“SEC”), in contrast, took a different approach when reviewing a proposal for a
bitcoin exchange-traded product and concluded that manipulation in the bitcoin
spot market precluded any kind of exchange-traded product tied to bitcoin. The
CFTC has very little jurisdiction over the cash market— the trading of Bitcoin
or other crypto-assets that are not securities for cash (or other crypto-assets
that are not securities). That’s where most of the trading of Bitcoin and other
cryptocurrencies takes place today. The agency can pursue cases of fraud and
manipulation in the cash market. It can also bring actions pertaining to retail
leveraged trades where there is a failure to deliver the commodity—that has
been the basis for some enforcement actions. as a general matter, it cannot set
oversight standards for the cash market in crypto-assets as it does with
derivatives on those crypto-assets. The cash market for crypto-assets—which is
where most of the trading takes place today—does not have well-developed
standards. This is a problem for oversight generally and for the quality of
crypto derivatives: if the underlying cash market is susceptible to (or
characterized by) fraud and manipulation, then what confidence can one have in
the derivatives? [Massad 2019]. Blockchain
technologies and cryptocurrencies in particular, are variously treated as
commodities, securities, property by different governmental agencies [Goforth
2019]. The list of governmental agencies impacted by cryptocurrency concerns goes
beyond the CFTC to include the SEC, FBI, Treasury, IRS etc. Resolving the
regulatory ambiguity and jurisdictional boundaries seems likely to take some
time.
References
[Al-Yahyaee 2019] K.
Al-Yahyaee, et al. “Volatility forecasting, downside risk, and
diversification benefits of Bitcoin and oil and international commodity
markets: A comparative analysis with yellow metal.” The North
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[Ali 2014] R. Ali, et. al.,
“The economics of digital currencies.” Bank of England
Quarterly Bulletin (2014): Q3.
[Bouoiyour 2019] J. Bouoiyour,
& R. Selmi. “How do futures contracts affect Bitcoin prices?.”
(2019).
[Das 2019] D. Das, et. al.,
“Does Bitcoin hedge crude oil implied volatility and structural shocks? A
comparison with gold, commodity and the US Dollar.” Finance
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[Geman 2019] H. Geman, &
H. Price. “Bitcoin Futures and Option Markets: Searching for Completeness.” Available
at SSRN 3457167 (2019).
[Goforth 2019] C. Goforth, “US
Law: Crypto Is Money, Property, A Commodity, And A Security, All At The Same
Time.” Journal of Financial Transformation 49 (2019):
102-109.
[Gronwald 2019]
M. Gronwald, “Is Bitcoin a Commodity? On price jumps, demand shocks, and
certainty of supply.” Journal of International Money and Finance 97
(2019): 86-92.
[Ji 2019] Q. Ji, et al.
“Information interdependence among energy, cryptocurrency and major
commodity markets.” Energy Economics 81 (2019):
1042-1055.
[Kogan 2019] Kogan, Allen.
“Not All Virtual Currencies Are Created Equal: Regulatory Guidance in the
Aftermath of CFTC v. McDonnell.” Am. U. Bus. L. Rev. 8
(2019): 199.
[Mathews 2019]
N. Mathews, & J. Robison.
“Smart contracts that violate the Commodity Exchange Act: which parties
are liable?.” Journal of Investment Compliance (2019).
[Platanakis 2019] E. Platanakis,
& A. Urquhart. “Should investors include bitcoin in their portfolios?
A portfolio theory approach.” The British Accounting Review (2019):
100837.
[Reiners 2019] Reiners, Lee.
“Bitcoin Futures: From Self-Certification to Systemic Risk.” NC
Banking Inst. 23 (2019): 61.
[Shahzad 2019] Shahzad, Syed
Jawad Hussain, et al. “Is Bitcoin a better safe-haven investment than gold
and commodities?.” International Review of Financial Analysis 63
(2019): 322-330.
[Shahzad 2019a] Shahzad, Syed
Jawad Hussain, et al. “Safe haven, hedge and diversification for G7 stock
markets: Gold versus bitcoin.” Economic Modelling (2019).
[Yermack 2013]
D. Yermack, “Is Bitcoin a real currency? An economic appraisal [nber
Working Paper no. 19747].” Available online at: National
Bureau of Economic Research
There are increasing concerns about data privacy and online security around the world; this is somewhat of a paradox, as users continue to give away personal data (and thus their privacy) in exchange for different services. A recent survey [CIGI-Ipsos 2019] on Internet security and trust found that 78 percent of Internet users in 25 economies were at least somewhat concerned about their privacy online. Internet scams of various types have also been demonstrated to raise internet users’ sensitivity to privacy issues [Chen 2017]. While economic development theory has long grappled with the consequences of cross-border flows of goods, services, ideas, and people, the most significant growth in cross-border flows now comes in the form of data. Some of these flows represent ‘raw’ data while others represent high-value-added data; this can make a difference in the trajectory of national economic development [Weber 2017]. Public awareness about privacy risks on the Internet is increasing; with the evolution of the Internet to the Internet of Things, these privacy risks are likely to become even more significant due to the large amount of data collected and processed by IoT architectures [Baldini 2018]. The Sony pictures hack[1] illustrates that privacy is not just an individual concern; unease over privacy expectations has emerged at the individual, governmental and international levels. Conceptually and methodologically, privacy is often confounded with security. [Spiekerman-Hoff 2012]. Gartner expressed a concern that the biggest inhibitor to IoT growth will be the absence of security by design[Gartner 2018] (which would include some aspects of privacy). While there has been considerable attention placed on some aspects of security, privacy has received less attention from the IoT community. Privacy was identified this year by Deloitte[2] to be the factor driving regulatory uncertainties over data management. This regulatory uncertainty challenges enterprises’ adoption of new technologies (like blockchain, or IoT). Social expectations for privacy are evolving, particularly in regard to aggregate representations of personal data in cyberspace. IoT devices and architectures are emerging as a major new data source for capturing representations of human activity. Rising cyberspace privacy concerns are moving beyond isolated activities like web browsing or social networks to consideration of the privacy impacts of the aggregate representation of personal data, including foreseeable data generation capabilities of IoT architectures. At a minimum, this creates a public relations problem for the deployment and operation of IoT Architectures.
IoT networks, like many other networks, are not technically constrained within geographical or political boundaries, but these political constructs may imply legal obligations for participants. Many of these legal notions of privacy evolved prior to the availability of the internet. International treaties like the UNDHR [UN 1948] and ICCPR [UN 1976] provide some definitional guidance on privacy rights, and [ALI 1977] identifies US common law privacy torts related to intrusion upon seclusion, appropriation of name or likeness, and publicity given to private life. These legal concepts, however, were all in place before the deployment of the Internet and the emergence of IoT. US legal requirements on privacy also come from a variety of other sources including constitutional limits, legislation, regulation, common law, and contract law; while litigation processes like discovery also implicate privacy. The Federal Trade Commission provides some cross-industry-sector privacy enforcement, but other industry-specific agencies in the health, finance, education, telecommunications, and marketing enforce industry-specific privacy regulations. States have also promulgated their own laws (e.g., on data breach notification and reporting obligations). [Solove 2006] proposed a privacy taxonomy with four main groups of activities that threated privacy (1) information collection (including surveillance and interrogation); (2) information processing (including aggregation, identification, insecurity, secondary use and exclusion); (3) information dissemination (including breach of confidentiality, disclosure, exposure, increased accessibility, blackmail, appropriation, and distortion); and (4) invasions (including intrusions and decisional interference). More recently, the General Data Protection Regulation [EU 2016] (GDPR) applies extraterritorially to protect EU citizens and has also been influential in other national privacy efforts. In particular, GDPR identifies roles in managing data (e.g., Data Protection Officers); rights for data subjects (including breach notification, access to their personal information, data erasure (the right to be forgotten), and data portability); and requires privacy to be incorporated into the design of systems (Privacy by Design). Globally, privacy laws are continuing to evolve towards bringing greater rights to data subjects [Greenleaf 2019]. Legal considerations on privacy generally revolve around the rights and obligations of legal entities; the IoT, however, is generally considered from the perspective of “things” and the data they generate or consume. The “things” in IoT are not usually considered legal entities, but many recent proposals for IoT architectures have been based on blockchains, and some have argued that blockchains could be implemented as Digital Autonomous Organizations (DAOs) structured to be recognized as independent legal entities (e.g., zero-member LLCs [Bayern 2014] or BBLLCs [Vermont 2018]). Manufacturers of IoT systems often seek the scale of global markets, and so cannot avoid these international trends in privacy regulation. IoT architectures have historically not emphasized privacy features, or considered IoTs operating as independent legal entities. The threats of increased regulation and the opportunities of new legal options will challenge existing IoT deployments and create opportunities for new IoT architectures.
The data we collectively create and copy each year is growing at 40% annually is estimated[3] to be around 44ZB/yr in 2020 (that’s around 6TB/yr for every person on earth), with much of this data expected (in future) to come from IoT devices sensing the world around them. Today, while people may choose to consume their portion of all their data as internet cat videos, many are not mindful of the digital footprints they leave in cyberspace [Camacho 2012]. An entirely new value chain has evolved around firms that support the production of insights from data. Individual data are worth very little on their own; the real value of data comes from the data being pooled together. [Beauvisage, 2017]. IoT provides a major new source of data for the big data value chain. Beyond intentional internet interactions, IoT sensor networks can also passively collect data on human activities. At the earlier stages of the data value chain, information content is limited, and therefore the scope for value generation is also low; at the same time, the data is more personalized and hence more susceptible to privacy threats. Some types of data should not be extracted, for instance, if it impinges on fundamental privacy rights. Some data, such as health data, may be usefully extracted under highly regulated circumstances. For many IoT architectures, the privacy threat arising from information processing (e.g., aggregated data) may be more severe than individual data samples. IoT data does not have to be as bandwidth-intensive and focused as video surveillance to threaten privacy. Patterns of private human activity can be discerned from aggregating data from disparate IoT architectures. The ownership and control options for IoT architecture generated data (as relating to human privacy) may be more complex than previous IoT architectures had considered – perhaps rather than centralizing data from IoT sensors in the cloud, IoT data may need to remain distributed, but responding to a limited set of authorized queries. Some actors may also have access across multiple IoT architectures providing a further degree of information aggregation and processing. Even IoT architectures intended for other purposes (e.g. environmental monitoring) may have the data they generate repurposed in ways that violate human privacy. For IoT architectures to succeed in large scale commercial deployments, they must be prepared to address evolving privacy concerns. This will require IoT architecture to identify which of the data they generate can implicate human privacy concerns.
Humans are interacting with vast amounts of data in new and unusual ways. Sensor density in consumer products is also increasing. Cyberspace historically was just an environment in which computer communication occurred; now it is already defined more by users’ social interactions rather than technical implementation concerns [Morningstar 2003]. Cyberspace computation today is often an augmentation of the communication channel between real people. People seek richness, complexity, and depth within a virtual world; and at the same time require increasing annotation of real-world entities with virtualized data in augmented reality. Humans increasingly use cyberspace for social interaction merging cyberspace and social spaces into social computing. The environments, however, are not the same; humans’ expectations and intuitions from the physical world do not always carry over into cyberspace. For example, real-world experiences are ephemeral; thanks to data storage, however, representations of personal data do not naturally decay; applying this to privacy violations, a transient real-world peeping incident equivalent in cyberspace could result in an ongoing data peeping threat. Legal notions of privacy are typically sensitive to the context (e.g., public spaces vs homes) and actors (e.g., people, organizations, governments). If IoT deployment scale projections are correct, then cyberspace in the near future will be dominated by data flows from IoT architectures. Cyberspace may create notions of new types of entities that may implicate privacy [Kerr 2019], and DAOs are one example of this. Devices are evolving to provide more “human-like” interfaces (e.g. voice assistants (e.g. Alexa, Siri) AI chatbots [Luo 2019]) and autonomous activity (e.g. UAV drones, Level 5 self-driving cars). The Apple iPhone 11 sensors include[4] faceID, barometer, three-axis gyro, accelerometer, proximity sensor, ambient light sensor, audio, and multiple cameras. The Tesla Model 3 includes[5] rear side and forward cameras, forward-facing radar and 12 ultrasonic sensors. The increasing data intensity in human experience is affecting human behavior and perceptions. While data generically is a very abstract concept, IoT sensor data is very much concerned with creating and aligning various linkages between physical reality and its cyberspace counterpart. Many actors may have an interest in the data about humans created by IoT devices and architectures. Beyond data ownership considerations, recent privacy legal initiatives have created new roles and additional obligations for operators of IoT architectures – e.g. GDPR’s rights to correct data or to be forgotten. The scope, scale, and serendipity of individual human interactions with cyberspace are reaching a qualitative change as IoT architectures become more pervasive.
The human-computer interaction (HCI) with the IoT blockchain is also an important factor affecting whether privacy enhancements are successful. Click through licenses can easily permit users to contract away their privacy rights (unless otherwise limited by regulation). There have been some efforts[6] to provide better exemplars of legal patterns for privacy information; adoption, however, is voluntary unless there is some superseding regulation (e.g., requiring specific notices to “opt-in” for certain types of information disclosures). Given the evolving nature of privacy concepts, HCI approaches may be helpful [Wong 2019] to better define users’ perceptions of the privacy problem space. Trademarks and certification seals may be useful [Wirth 2018], [Bansal 2008] for consumers to identify and trust products and services that provide privacy assertions (e.g., conformance to privacy regulations such as the GDPR). Beyond disclosures, new privacy rights create functions (e.g., for authorized modification or deletion of data) that need to be supported in IoT architectures. The effectiveness of such functions in providing humans with more advanced controls of their personal data will depend in large part on their ease of use. The usability/ operability of such user controls of their data will also be impacted by the visibility and accessibility of the privacy controls. IoT use cases need to evolve to consider these new roles and functions within IoT architectures and how humans can effectively use them to maintain control of their privacy.
Two fundamental technology trends are driving the Internet of Things (IoT). Firstly, the continued miniaturization of devices through Moore’s law, nanotechnology, new materials, etc., is providing an increased density of functionality in devices, and a consequent increase in the variety and volume of the data these devices can generate and consume. Secondly, the number and quality of connections are increasing. Gartner estimated[7] there would be 8.4 billion connected Internet-of-Things (IoT) devices in use worldwide in 2017 and projects an increase to 50 billion by 2020. IoT use cases are one driver for 5G deployments and these deployments are also expected to increase connectivity density towards ubiquity in many areas. Ericsson estimates[8] there will be 1.5 billion IoT devices with cellular connections by 2022 with cumulative annual growth rates on the order to 20%-30%. This is significantly faster growth than the US GDP growth (estimated[9]in the range 2-3% 2018-2019) or world population growth rates (estimated[10]at 1-2%). Even the job outlook for software developers is only expected[11] to improve by ~21% (2018-2018). The number of IoT devices and their connectivity is evolving the Internet to be primarily an Internet of Things, where the IoT devices, and the data they communicate, forms the dominant usage pattern. This massive IoT investment comprises multiple information infrastructures; forming a cyberspace data environment within which people will interact for an increasing portion of their lives. With massive IoT deployments expected within the next 5 years, to avoid stranded investments, it is important to get the appropriate IoT architecture requirements in place to address common human concerns, particularly around privacy. Existing IoT deployments will also be impacted by privacy as public relations headwinds, evolving regulatory requirements on management of IoT data, changing human attitudes due to the qualitative changes in cyberspace experiences from pervasive IoT environments, and increased user control of IoT data. Retrofitting privacy (or security) into an existing distributed architecture is unlikely to be simple cheap or complete. New IoT architectures must consider privacy impacts.
[CIGI-Ipsos 2019]
CIGI-Ipsos, UNCTAD and Internet Society (2019). 2019 CIGI-Ipsos Global Survey
on Internet Security and Trust. Centre for International Governance Innovation,
UNCTAD and the Internet Society. Available at: https://www.cigionline.org/internet-survey-2019.
[EU 2016]
European Union: Regulation (EU) 2016/679 of the European Parliament and of the
Council of 27 April 2016 on the protection of natural persons with regard to
the processing of personal data and on the free movement of such data, and
repealing Directive 95/46/EC (General Data Protection Regulation)
[Morningstar 2003]
C.Morningstar, et. al., The Lessons of Lucasfilm’s Habitat. The New Media Reader.
Ed. Wardrip-Fruin and N. Montfort: The MIT Press, 2003. 664-667.
[Solove 2006] Daniel
J. Solove “A Taxonomy of Privacy”. U. Pa. L. Rev., 154:477–560, 2006.
“What gets us into trouble is not what we don’t know. It’s what we know for sure that just ain’t so.” ― Mark Twain
Under current taxation regimes, cryptocurrencies are treated
as property by the IRS,
which implies a host of existing rules and regulations regarding the reporting
and taxation of property transactions. This
reporting and tax collection can be manually burdensome and is rarely automated
given the current state of the technology. The IRS has recently started
increased enforcement actions
on cryptocurrency transactions. Blockchain and cryptocurrency enthusiasts have
sought to apply some of the underlying technology and concepts in a variety of other
ways to avoid these burdens. One
proposed use is in customer loyalty programs.
Customer loyalty programs can provide differentiation and sustain competitive advantages, particularly where the switching costs are low[1]. Customer loyalty programs have a long history with applications in the 1700s and 1800s with tokens and stamps that could be used by the customer for discounts on future purchases with the same supplier. Perhaps the modern stereotype is the frequent flyer mile. Originally acquired and used solely for air travel, these can now be acquired without using air transport and exchanged for a variety of other goods and services. While typically not fungible beyond the partner ecosystem, customer loyalty tokens (e.g. frequent flyer miles) are sometimes seen as alternative currencies by both the creators and users. The analogy with cryptocurrency schemes as an alternative currency seems obvious.
Most consumers don’t think about taxation of their frequent flyer miles; and, most would typically assume that they are not taxable. This, unfortunately, ain’t always so. The IRS has issued limited guidance on the taxation of frequent flyer miles with IRS announcement 2002-18 stating they would not pursue a tax enforcement program on frequent flyer miles – and not that these were not taxable. This relief does not apply to travel or other promotional benefits that are converted to cash, to compensation that is paid in the form of travel or other promotional benefits, or in other circumstances where these benefits are used for tax avoidance purposes. And there are a couple of court cases[2] where the value asserted in a frequent flyer miles transaction has exceeded de minimus limits and resulted in the issuance of 1099-MISC income statements with tax impacts. There are many variants in customer loyalty programs and opinions on the practicality of heir taxability[3]. Unexpected tax enforcement against consumers of loyalty program tokens would significantly impact the value of such programs. No consumer-facing company wants to give its customers promotional tokens that result in tax problems from unexpected liabilities or reporting concerns.
Considering the potential for increased tax enforcement against cryptocurrency transactions, proponents of blockchain-based customer loyalty programs should consider how closely their proposed loyalty programs match the original concept of discounts against future purchases with the same supplier vs fungible alternative currency.
For companies considering a blockchain-based loyalty program there are additional considerations. FINCEN has recently issued guidance involving convertible virtual currencies. While this guidance seems directed to virtual currency exchanges, it is not clear that businesses exchanging virtual currencies for goods and services are exempt. If applicable, then the business would need to comply with state money transmission regulations. This gives companies considering blockchain-based loyalty programs added incentives for restricting the program to match the original concept of discounts against future purchases with the same supplier vs fungible alternative currency.
Blockchain-based customer loyalty programs are not impossible; however, due diligence needs to be undertaken with the applicable regulations, to ensure the loyalty program is designed appropriately.
