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Top 3 Blockchain predictions for 2019

by Elisa Rosati and Tommaso Ricci

Last year was a major tipping point for blockchain, with a powerful kickstart followed by some turbulence and a cautious settlement in the freezing winter.

Here are our top 3 predictions for the next 12 months which might be crucial as the technologies and applications exploiting blockchain seem ready to have a real impact on the market.

 1. Losing the crypto fingerprint

Throughout 2018 we witnessed the biggest crypto-currency rally ever with major fluctuations in the crypto-market weakening the confidence of investors. It is now time for the blockchain to finally detach from its crypto fingerprint and overcome the volatility skepticism.

2019 will be the year to separate blockchain from crypto in the minds of business by proving that blockchain is not simply the technology at the heart of virtual currencies. Indeed, blockchain can have numerous use cases that are completely unrelated to cryptocurrencies as it offers a totally different approach to storing information, performing functions, making transactions and establishing trust.

Of course, initial coin offerings (ICOs) and token generation events will continue to proliferate in the next months, but after the 2018 «tokenization hype» the blockchain-enabled methods of raising funds will become more stable and mature as investors’ awareness and governments’ attention grow up.

Indeed, European institutions are engaged in a discussion about creating a single regulatory approach for online capital formation for securities, including ICOs and there is an expectation that Europe will introduce harmonized rules to be enacted in 2019.

The EU Parliament recently issued its report on the proposal for a regulation on European Crowdfunding Service Providers for Business, stressing the need to overcome the fragmented regulatory ecosystem issuing an ad hoc legislative framework for ICOs. Improved legal certainty across the EU could be instrumental to increase sector growth and access to capital by reducing compliance costs to operate in multiple Member States and increasing investor and consumer protection.

At present, the legal framework is still uncertain because the approach taken by regulators differs widely from jurisdiction to jurisdiction and  –  as clearly identified in the recent DLA Piper global ICO Compliance Survey –  for a coin or security token offering to succeed it is vital to involve legal teams early, alongside technology and corporate advisers.

In this scenario a GDPR alike harmonization effect is expected within EU and only cryptocurrencies that really deliver added value and provide adequate compliance safeguards will stand.

This circumstance will have also a positive effect on regulations since governments are likely to stop looking at blockchain as just the technology behind bitcoin, but rather as a technology with considerable potentials to be exploited.

2. Legislative boost to catch the opportunity of blockchain

2018 was a tough pilot year to establish how the distributed leger technologies (DLT) behind blockchain could be improved and what problems they could solve. A number of successes and failures came out of the blockchain testing ground, moving technology providers from pilots to real-life products and services. Consequently, a global legislative challenge has been going on with countries all over the world stepping into the blockchain game to seize the opportunities offered by DLT.

The proofs of concept have shown that DLT-based applications can actually reduce intermediation costs in a trusted environment between the transacting parties and allow peer-to-peer exchange of value that can empower citizens, disrupt legacy models, improve services and reduce costs throughout value chains in a wide range of key sectors, such as energy, healthcare, financial services, supply chain management, manufacturing, transport, education, creative industries and public services. What the 2018 POCs have also shown is that opportunities bring also risks both related to technical limits stemming from asymmetric information and to fraudulent behavior and illegal activities such as unpermissioned blockchain applications for tax evasion, tax avoidance and money laundering.

This is the reason why regulators are rushing to deploy a comprehensive and future-proof legislative framework in order to tackle cybersecurity, interoperability and data protection issues raised by blockchain.

While US authorities have cautiously started to regulate quite extensively the sector, issuing some controversial security-related rules, East Asian countries by contrast have until recently taken a “business first, regulation later approach“, allowing blockchain companies to operate without restrictions. But with the crypto meltdown of last year, East Asian nations also began to make blockchain subject to a more significant regulatory scrutiny.

Meanwhile European countries have started to create a comprehensive legal framework quite fast. The Maltese Parliament for example recently adopted three bills, including the Virtual Financial Asset act, providing a holistic regulatory framework for DLT and cryptocurrencies thus becoming the biggest EU hotspot for blockchain and coin offering companies.

Overall the EU is well placed with a digital single market of 500 million citizens where individuals and businesses can seamlessly access and engage in online activities under conditions of fair competition, and a high level of consumer and personal data protection. EU institutions are working together with governments and the industry to overcome regulatory obstacles, increase legal predictability and lead international standardization to accelerate research and innovation. In parallel, through the eIDAS and GDPR regulations, as well as the European Commission proposals on e-privacy, the regulatory framework is gradually being shaped at European level and also by Member States.

Indeed, as blockchain can bring great improvements for multiple industries – from start-ups to large corporates, administrations and citizens – more legal certainty will enable the industry to mature and gain the legitimacy needed to experience a much wider adoption.

Aiming to bring together companies interested in exploring the potential of blockchain and distributed ledger technologies to transform digital services at a global level, during 2018 the EU launched the European Blockchain Partnership, in which 27 EU Member States have joined so far, including Italy, which in 2019 is planning to lead investments in distributed registers and blockchain through a venture capital fund for innovative startups and is simplifying procedures and reducing burdens for startups, innovative SMEs and incubators, opening the door for a Made in Italy Blockchain leveraging the customers’ needs of enhanced food authenticity and safety.

Furthermore, the Commission launched the EU Blockchain Observatory and Forum as well as a study on the feasibility of an EU public blockchain infrastructure to develop cross-border services and most notably in October the EU Parliament has passed a resolution on distributed ledger technologies and blockchains: building trust with disintermediation.

A major reason of the adoption of the resolution is to empower and protect EU citizens and startups in relation to the centralized banking system, while enabling EU companies and institutions to fully grasp the potential of the DLT, in the spirit of technological and business model neutrality.

Among the multiple recommendations and call to action, most notably the resolution pushes EU institutions and Member States to:

  • develop technical standards for Distributed Ledger Technologies;
  • enhance legal certainty by means of legal coordination or mutual recognition regarding smart contracts;
  • identify dangers for the public and incorporate cryptocurrencies into the European payment system;
  • evaluate and tackle cybersecurity, interoperability and data protection issues; and
  • create funding opportunities and an Observatory for the monitoring of ICOs.

This move, together with the digital single market strategy and recent data centric law-making (like the GDPR, the regulation on the free flow of non-personal data and the draft ePrivacy regulation), confirms that the European Union aspires to become the global leader in the fourth industrial revolution.

We expect that in 2019 the follow up of the EU resolution on DLT will enable the progress of digital services at a global level by setting up a true interoperability standard for optimal communication between different types of blockchain networks, perhaps opening the door to some more hybrid deployments.

3. Solving the scalability trilemma and ensuring GDPR compliance

To widespread the adoption of blockchain, operators have been trying to find a balance among scalability, security and decentralization. All three are required, yet only two can be concurrently obtained and in 2019 the so-called scalability trilemma problem will be (hopefully) solved.

This apparently intractable trilemma of technical barriers has undermined the trust and capabilities necessary for a widespread adoption and many projects have been cutting corners too much in one area.

One of the biggest success factors of blockchain is indeed its capacity to enable trustworthy transactions between a group of non-trusting individuals, without needing a central party to control and validate each and every transaction. So as to ensure security, decentralization of the “controlling power” is required and all nodes on these blockchains must reach consensus before they accept a transaction. On the other side scalability ensures that the application runs quickly and that it can support a high volume of transactions but quickly growing networks enhance the security risks and require a fast consensus mechanism (i.e. a decentralization key) in order to validate more transactions while delivering the same speed to individual users. However, several projects claiming to employ blockchain are still lacking in decentralization and with data distributed among many ledgers, legal risk remains with liability spreading across all participants to a blockchain.

Moreover, as noted by the EU in its DLT Resolution referred above, at the present in the market there is a constellation of DLT technologies with various technological characteristics as well as different mechanisms concerning governance (permissioned and permissionless distributed ledgers) and consensus.

In order to ensure efficiency and enable scalability the standardization issue has to be solved. In 2019 hopefully the governmental institutions across the globe and other international organizations such as ISO will cooperate to deliver standards settings and rules to enable full interoperability  between applications built on the same DLT and between DLT and legacy systems. In this sense the EU Blockchain Observatory will constantly monitor technological developments to ensure that upcoming projects ensure the sustainability and security of DLT platforms.

Much work has already been done to figure out solutions to overcome the current key issues with different scaling solutions, such as sidechains, in order to maintain censorship resistance, open participation and immunity from attacks thus allowing blockchain transactions to become faster and scalable while designing different degrees of consensus solutions that preserve security and meet users’ requirements and tolerance for centralization.

However, in order to ensure DLT prosperity in the future, throughout 2019 the Blockchain market players will not only tackle the issue of whether blockchain is or can be made to be scalable and sufficiently decentralized at the same time, but it shall also be made secure and  compliant with EU-wide data protection standards.

The compliance of the impossibility to remove information from the distributed ledger with the GDPR’s right to be forgotten for instance has been challenged in several instances.

As shown by last year’s reports issued by the French Data Protection Authority (CNIL) and the European Union Blockchain Observatory and Forum, transactional data recorded on a blockchain that can be linked to an individual are likely to fall under the category of personal data, thus requiring to satisfy privacy requirements. The CNIL recommends first of all to assess whether blockchain is the appropriate technology for the intended use case. If personal data are to be used, a GDPR-compliant structure shall be implemented which enables a continuous assessment, evaluation and mitigation of the related information, security and data protection risks.

In any case the appropriate strategy to implement and deploy a DLT technology must be assessed on a case-by-case basis in order to avoid creating a data-safe solution that prevents the achievement of commercial business goals.

Conclusions

As foreseen in our 2018 predictions, the distributed ledger technology is already largely adopted in the financial sector, with an increasing number of smart contract-based bonds and loans being issued across the globe, and many further applications have been deployed in the last year to solve cybersecurity issues, boost the IoT business and speed up legal compliance through several automated legal tech tools.

After the pilots and tests, the technology is almost mature and ready to become more operational and integrated into an increasing number of digital services, such as regulatory reporting, energy and logistics. However, as the blockchain ecosystem evolves, there are a number of legal issues that need to be carefully addressed before business can start to fully seize the potential benefits.

Companies should be able to address the inconsistent regulations across multiple jurisdictions and overcome the technical limits in order to meet the markets’ needs while looking ahead toward regulations yet to come.

 

If you would like to know more about our blockchain predictions, please contact elisa.rosati@dlapiper.com and tommaso.ricci@dlapiper.com.