Legalize Blockchain: How states should deal with today's most promising technology to foster prosperity

By Thomas G. Duenser

In the last decades, digitalization has been enormously pushing innovation with a stunning impact on economy and society. In this book, the author illustrates that blockchain is one strong driver of the future digital economy, enabling a higher level of efficiency, trust, and legal security. As regulation can decide how a jurisdiction can participate in this development, the author discusses the current and future regulatory challenges and explains, why applying financial market laws for all Token Economy is not appropriate and would hinder its development.
Consequently, he argues for a new regulatory fundament for Token Economy - as the Principality of Liechtenstein has introduced in 2020 - and explains the political regulatory decisions of the so-called »Blockchain-Act«. The author pleads also in favour of establishing a new regulatory framework for Token Financial Markets and drafts its cornerstones. In addition to that, he describes the need for an innovation process for the legal framework and emphasizes the importance of the innovation culture of governments and authorities to keep pace with the technological developments and ensure future prosperity.

• Language: English
• Publisher: Books on Demand
• Release date: Jun 29, 2020
• ISBN: 9783751913379

Thomas G. Duenser

Thomas G. Duenser is the director of the Office for Financial Market Innovation of the Principality of Liechtenstein. Since 2015, he has been supporting fintech- and blockchain-companies in questions regarding the legal and business framework. He also was responsible for the development and the introduction of the Liechtenstein »Block-chain-Act«, the first comprehensive regulatory framework of the To-ken Economy in the world. Among others, his professional experience covers a leading position in the treasury and financial risk manage-ment department of a bank. He holds a PhD in mechanical engineering of the Swiss Federal Institute of Technology.

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This book is dedicated

to all who see

change as a chance

to jointly realize

a better future.

ABOUT THE AUTHOR

Thomas G. Duenser is the director of the Office for Financial Market Innovation of the Principality of Liechtenstein. Since 2015, he has supported Fintech- and blockchain companies in legal and business framework questions. He was also responsible for developing and introducing the Liechtenstein »Blockchain Act«, the world's first comprehensive regulatory framework of the Token economy. Among others, his professional experience covers a leading position in a bank's treasury and financial risk management department. He holds a Ph.D. in mechanical engineering from the Swiss Federal Institute of Technology.

FOREWORD BY PRIME MINISTER ADRIAN HASLER

We are living in the age of digitalization. For many decades, we are all affected by technological innovation, whether we like it or not. Especially in the last 20 years, the speed of innovation has been increasing exponentially. The ability to innovate belongs to the core competencies of this century. But it is not only businesses affected, but also the legal framework and the work of authorities and governments. Especially in densely regulated sectors such as the financial markets, the ability to cope with innovation by the state is essential to foster economic development and future prosperity.

For this reason, I have introduced a governmental framework for innovation called »Impuls Liechtenstein«. Within this framework, we installed processes and resources that support innovative business. We have also initiated a cultural change within the authorities to enable innovation in Liechtenstein. With these measures, we want to contribute to maintaining prosperity and attractive jobs in Liechtenstein. This innovation framework was why an active Fintech community has evolved in Liechtenstein and why we were positioned to develop the first comprehensive regulatory framework for the Token economy.

We are living in an exciting but challenging time. The lecture of this book will help you understand Blockchain's legislation challenge and contribute to this very promising development, either from the regulation or business perspective.

Adrian Hasler, Prime Minister of Liechtenstein

CONTENT

1. Background Know-How about Bitcoin and Blockchain

1.1. Bitcoin

1.2. The Blockchain-Protocol

1.3. Functional Elements of Any Blockchain System

1.4. Further Generations of Blockchains

2. The Use of Blockchain

2.1. Blockchain as a Register Technology

2.2. The Main Innovation of Blockchain

2.3. Tokenization

2.4. Digital Contracts on Token Basis and Digital Identity

3. Token Economy

3.1. Concept

3.2. Use Cases of Token Economy

3.3. Token economy as a Worldwide Legal Transaction Layer

3.4. Functional Overview of the Token Economy

3.5. Architecture of the Token Economy

3.6. Blockchain-Systems Provided by the Government

4. Blockchain and the Banking System

4.1. The Banking System

4.2. Bitcoin as a Private Monetary System

4.3. Role of Digital Money in the Digital Economy

5. Blockchain and Financial Market Regulation

5.1. Banking Regulation and Token Economy

5.2. Securities Market Regulation and Token Economy

5.3. Investment Fund Regulation and Token Economy

5.4. Portfolio Management Regulation and Token Economy

6. Regulation of Blockchain and Token Economy

6.1. Goals of Regulation

6.2. Classification of Token

6.3. Regulation of the Token

6.4. Regulation of the Token Economy

6.5. Level of Regulation Regarding the Token Economy

6.6. Innovation of the Regulatory Framework

6.7. Token Financial Market Regulation

7. Blockchain and Prosperity

7.1. Token Economy, Innovation, and Investments

7.2. Access to Financial Services

8. Political Strategy Regarding Blockchain

9. Summary and Outlook

INTRODUCTION

Almost no other topic has been so intensively discussed in the last years as Blockchain: For some people, it is the solution to nearly everything. For others, it is an incorporation of evil. But we must be aware that Blockchain is »only« a technology. And as with every technology, it can be used for the good and the bad. It is, therefore, crucial to understand the power of this technology and its potential applications if we want to judge it fairly. This is especially important for representatives of a state since their decisions will define to a large extent how the applications of this technology can develop.

This book contributes to the ongoing discussions about the regulation of Blockchain.

Blockchain was introduced in 2008 for bitcoin, a private monetary system as a counter-model to the public monetary and banking system. In the last years, many further applications followed: The issuance of other digital money (called »cryptocurrencies«) or so-called »utility coins«, exchange and trading platforms of cryptocurrencies, bitcoin-ATMs, the use of cryptocurrencies for speculation reasons, the use of cryptocurrencies for financial services, the issuance of digital securities. Since most of the first applications are close to or in the financial market, an intensive discussion about applying financial market rules to the several applications of this new technology appeared. But as the blockchain-technology offers a new kind of efficient transaction system without intermediaries, some fundamental questions had to be answered. In addition, criminals soon started to misuse this technology for ransom payments, fraud, illegal transactions, and money laundering.

In the last few years, many countries have intensively discussed the current applications of Blockchain. From the perspective of a state, these first applications bear more risks and problems than positive aspects. So, Governments might naturally tend to focus on solving these problems and reducing the risks.

But blockchain technology also offers an entirely different scope of application. Blockchain enables a fascinating development in the context of the digitalization of the whole economy. It helps to solve one fundamental challenge of digitalization: to prevent digital information from being easily copied. This feature allows for a new level of digital business processes and legal transactions, combined with high legal security and efficiency. It might trigger one of the most important economic developments of the following decades, helping to create new business models, new business segments, and future prosperity and jobs. This scenario often is summarized under the term »Token Economy«.

A country's regulatory approach is crucial for further developing the Token economy in this jurisdiction. Regulation can hinder or can foster its development. Even the absence of regulation can hamper Token Economy because of the lack of legal certainty, especially regarding applying financial market laws. For prudent regulation decisions, it is crucial to see the full potential of blockchain technology.

In charge of supporting business innovation in the financial markets in the Ministry of Finance of Liechtenstein, I have come in close contact with concrete business applications of Blockchain in Liechtenstein at a relatively early stage. My colleagues and I have discussed with those pioneers their plans and how they are compatible with the regulatory framework. Because of those dialogues, we realized the potential of blockchain technology very soon. End of 2016, Prime Minister Adrian Hasler installed a working group to explore the chances and risks relating to Blockchain, which I was heading. The working group was composed of only initially six (and in a later stage, nine) experts from the private sector, government, financial market authority, and university, covering knowledge about Blockchain, Fintech, regulation, and law in general. As one result of this work, Liechtenstein introduced on January 2020 the so-called »Blockchain-Act«, the first comprehensive regulatory framework of the »Token-Economy«.

After several years of intensive discussions about the blockchain-technology, the token economy, and its legal framework, I have concluded that this technology will lead to a fundamental change in our Economy and financial market. Blockchain unleashes a strong power of innovation, touching almost all aspects of the digital economy. In my opinion, the positive applications are dominating potential negative use. Blockchain has not only a positive impact on economic growth and prosperity, but it also has a great potential to solve problems that the United Nations have formulated in the Sustainable Development Goals (SDG). In other words, Blockchain can also help to create a better world, in my opinion.

As mentioned before, this book is intended to contribute to the current and future discussions about blockchain regulation. Finding the right way of regulating means involving several fields of knowledge: It is necessary to understand blockchain technology and the current and future applications of Blockchain in the general economy and the financial markets. Hence, it is necessary to understand the functioning and the scope of regulation of the financial markets and the banking system, to see the difference to typical blockchain applications and to find out if financial market regulation should be applied. I tried to cover all aspects necessary to understand the conclusions I propose in the book's main chapters. Some readers certainly already know the fundamentals. Please feel free to skip the related chapters. Others might wish to learn more in detail. To focus on the main chapters of this book, I had to restrict the scope of the fundamental chapters to the most important aspects. There are many excellent publications currently available for interested readers. Some chapters of this book also relate to the Liechtenstein »Blockchain-Act« and our experiences in the legislation process and explain the several strategic decisions we have made. This book is addressed to several groups of readers: First, it is written for all representatives of other Governments working on decisions about the legal framework. It should support them in their decision-making, helping them see blockchain technology's full potential. Second, it is addressed to all people interested in economic development. The book should help to understand the potential of Blockchain as well as to have an insight into the ongoing regulatory discussions. Third, this book is also written for the blockchain community members wanting to understand the perspective of the states, the financial market, and the banking system, as well as the legal framework. There might be some readers that are missing quotations. As this book is not intended as a scientific publication, I decided to refrain from quotations, as they usually do not increase the reading comfort. But I certainly do not want to claim that I am the »originator« of all information contained in this book, especially in the introduction chapters. This book is based on several years of intensive discussions with the blockchain community, regulators, and financial market participants. I consider it one of my roles to condense and translate this information so that readers without deep knowledge in one of the related fields have easier access to the essential discussions and can make their judgments. Furthermore, this fundament is necessary to understand the ideas and concepts I have developed in the main chapters of this book.

ACKNOWLEDGMENTS

I would like to thank all persons that have accompanied and supported me in the last years during the introduction of the innovation framework in Liechtenstein and the development of the »Blockchain Act«. It would take too much room to personally name all colleagues and entrepreneurs who have contributed to this development, particularly the »Blockchain Act« in Liechtenstein. However, I want to give a special and warm thanks to those who joined the working group »Blockchain« of the Government of Liechtenstein in 2016. Their knowledge and ability to share and develop the vision of a proper blockchain regulation laid the fundament of the later regulatory approach: Patrick Bont, Johann Gevers, Thomas Naegele, Thomas Nigg, and Peter Schnuerer. I also want to thank Hans Kuhn and Thomas Feldkircher for their outstanding contributions.

A special thank is dedicated to my family, especially to my wife Martina, who tolerated that I used my spare time to write this book, including inspiring discussions about all aspects of Blockchain and beyond.

1. BACKGROUND KNOW-HOW ABOUT BITCOIN AND BLOCKCHAIN

»Blockchain« was invented for the concept and the implementation of »bitcoin«. But Blockchain is much more than bitcoin. It is one core element of many interesting developments in the last decade. We will probably see them in the next decades, such as the Token Economy and Token Financial System. This chapter will summarize the essential aspects of Bitcoin and Blockchain to better understand the following chapters. Even if the basic concepts of Blockchain are relatively simple, the complexity of all technical details and different variations of blockchains is quite high. Somebody interested in all the various details can certainly spend time studying. As many excellent books about Bitcoin and Blockchain describe all technical details perfectly, there is no necessity to cover all details here again. I, therefore, focus on the most important elements and characteristics from the perspective of this book. Readers with knowledge about Blockchain may skip this chapter and start with the following chapter.

1.1. BITCOIN

The concept of bitcoin was published in a so-called whitepaper in 2008 by a pseudonym named Satoshi Nakamoto. It described the concept of a digital or electronic cash system, where private persons can send money to other private persons via the internet without using the payment infrastructure of the banking system. Nakamoto first had to solve a problem that is called the »double spend problem«. If we create digital cash, e.g., a digital banknote (it could also be a banknote issued by a central bank), we must ensure that the banknote may only be spent once. Otherwise, the value of the banknotes would rapidly decline. Nakamoto solved this problem by creating the blockchain protocol, which in principle, is a database for money transfers and ensures that the same money cannot be spent twice by the same person.

Another important part of the whitepaper on bitcoin covered the creation of private money (bitcoin). This money's value is not derived from any real-world value (e.g., gold) but by clear rules defined in software code. Those rules cover aspects like the maximum amount or how new money is created (»mining«).

Bitcoin is not only thought of as a counter-model to the banking transaction system. It can also be seen as a counter-model to central banks' money.

1.2. THE BLOCKCHAIN-PROTOCOL

As mentioned above, the blockchain protocol was created as a register (or ledger) for digital money transfers to prevent double-spending money. For that purpose, all transactions are stored sequentially and – together with other transactions – sealed using cryptography technology. Those sets of sealed transactions are called »blocks«, so the sequence of many blocks can be seen as a chain of blocks or »blockchain«. In addition to the encryption of one block, a technical check figure (hash) is created that summarizes all transactions in one block and is put as a start to the next block. By that, manipulating a single transaction in the Blockchain would cause the whole Blockchain to be invalid. So, every try to manipulate a single transaction can only be successful if the whole chain is recalculated. Today, this seems almost impossible with the current computing power, but it might be possible with future super-computers such as quantum computers. In that case, the encryption technology used for encrypting blocks also has to emerge in future generations of the blockchain-technology.

The sealing of transaction blocks is provided by so-called »miners«, specialized computers or servers. This service is rewarded with new bitcoins. The mining process is technically and mathematically rather interesting, but as this is not necessary for