Law of Cryptocurrencies 101: Development of Cryptocurrencies and Their Effects on Law

Foreword

Cryptocurrencies are defined as technologies that aim to distribute the power, power of governance and regulation—which are agglomerated on central authorities—to the members of society. Cryptocurrencies have a huge market value, and the volume of transactions increases every day. In today’s world, cryptocurrencies, crypto monies, and other crypto assets are used as a source of investment. Because of the regulations of governments, they cannot be used as a tool for people to maintain their daily activities without a central authority. Therefore, it cannot be counted as the main aim behind the development of cryptocurrencies. In addition, because of these restricting regulations, neither countries nor citizens can benefit from this huge economic value in maximum level and it causes the usage of crypto assets as a source for black economy. By regulating the usage of cryptocurrencies, countries can benefit from their economic value and the link between these currencies and black markets can be cut. Moreover, during economically difficult times, people can use them as a source of transactions and earning money; as well as decentralized technologies, who can develop faster without harming the sovereignty of the states. In brief, the regulation of cryptocurrencies is beneficial for both countries and individuals about these aspects. This series is going to enlighten the readers about which legal remedies can be generated to use these modern technologies in our daily lives.

This 101 series is divided into seven chapters, with each providing a distinct discursive element on the legal environments of cryptocurrencies.

1. Law of Cryptocurrencies 101: An Introduction, Development of Cryptocurrencies and Their Effects on Law

2. Law of Cryptocurrencies 101: Legal Turbulence and Asset Dilemmas of Cryptocurrencies and Other Crypto Assets

3. Law of Cryptocurrencies 101: Regulations about Cryptocurrencies in America: In North American and South American Countries

4. Law of Cryptocurrencies 101: Regulations about Cryptocurrencies in Asia: China, Russia and Others

5. Law of Cryptocurrencies 101: Regulations about Cryptocurrencies in Europe: United Kingdom, France, Germany and Others

6. Law of Cryptocurrencies 101: Regulations about Cryptocurrencies in African Countries

7. Law of Cryptocurrencies 101: Dispute Resolutions by Using Decentralized Systems: Resolutions For Cryptocurrencies

Law of Cryptocurrencies 101: Development of Cryptocurrencies and Their Effects on Law

The Revolution of Blockchain, Cryptocurrencies and Smart Contracts

Money can be defined as a social convention that facilitates the trade and solves the problem of the lack of trust in exchange (Demertzis and Efstathiou, 2018). According to the law system of Turkey and Switzerland, money is a tool for payment and for trade (Turanboy, 2019). Today’s global financial system is constituted on monies controlled by the states, and it causes several problems. Human society have faced these problems during economic crises and hyperinflation periods. The last economic crisis that the world suffered before the pandemic of Covid-19 was in 2008. During this recession, a man called Satoshi Nakamoto has established an article that pinpoints the problem of lack of trust in the current financial system, high prices of third party mediated transactions and long money transfer processes. He demonstrated the need of a cryptographic system between two parties without the intervention of third parties, a system based on trust (Satoshi, 2008). By this starting point, blockchain technology and its related production, cryptocurrencies were born.

Blockchain

Blockchain technology is the infrastructure behind cryptocurrencies of today. By this technology, pieces of information are linked by bundled blocks, and they are encrypted with a cryptographic procedure. It includes a decentralized and mathematical verification process (Hacker and Thomale, 2018). The distribution of tokens in the relevant blockchain system is made by the underlying company and the relevant blockchain protocol. In traditional registration systems, a central server or authority allocates whole data about individuals or legal persons. Blockchain is a distributed ledger and in order to understand if a transaction is made or not, the whole system has to be watched and it can be made by a procedure called proof of work. In other words, proof of work solves the problem of representing the decision of the majority. Whole blocks in the chain represent a proof of work that is distributed to the whole chain by a value called 'hash'. By this system, it is extremely difficult that a hacker or cyber attacker can hack the system or change the data in the relevant system (Satoshi, 2008).

Figure 1: Satoshi's Demonstration on How Blockchain Works.

Cryptocurrencies

Cryptocurrencies are governed by non-governmental organizations. In today’s world, they are more convenient than paper, plastic, metal and printing materials (Sapovadia, 2015). Promoters require no material resources to produce crypto monetary units. They are stored in computers, and they are minted by different software. All transactions are made via Internet connection anonymously, without third party intervention (Sapovadia, 2015). Cryptocurrencies have countless benefits: low costs of transfers, relative rate of flow between different individuals in different countries, simplicity and flexibility for the users and independency of capital movement from current banking operations (Drozd et. al., 2017). There are more than 10.000 types of cryptocurrencies and their market value is close to two trillion dollars. The most valuable crypto monetary units are Bitcoin and Ethereum, which comprise more 50% of total cryptocurrency market. Besides these two monetary units, there are others such as Ripple, EOS, Litecoin, Cardano, TRON and IOTA (Gregory et. al., 2018).

To make cryptocurrencies effective on global economy, there are different necessities. Firstly, the supply of the cryptocurrencies must be effective on global economy as an instrument of monetary unit. Secondly, there needs to be a check and balances system for the supply of the cryptocurrencies. They have to be integrated to a democratic society too (Demertzis and Efstathiou, 2018). On the other hand, there is a volatility problem of cryptocurrencies. Their borderless structure can be a major issue: they are not linked to a certain system of jurisdiction. This causes an inability to adjust exchange rates in different countries (Gregory et. al., 2018). Cryptocurrencies are legal in some countries but, for many of them, it cannot be said that whole necessary legal regulations are made. They are neither declared as legal nor illegal in these countries (Sapovadia, 2015). It is found that the recognition of digital currencies is largely related to the state development. Countries which have weak economies tend to prohibit digital currencies. Instead, developed countries try to find new ways to legislate and tax these monetary units (Drozd et. al., 2017).

Smart Contracts

Smart contracts are codes that are encrypted on the relevant blockchain protocol and function automatically, without human involvement. Smart contracts were born with the Ethereum protocol, by a man called Vitalik Buterin. For him, smart contracts are codes in blockchain system which automatically move digital assets conformably with arbitrary rules that parties choose. They are encoded bylaws of the entire blockchain protocol and parties have a right to define the law they are going to be obliged to. Financial derivatives are the simplest forms of smart contracts (Buterin, 2014). On the other hand, the most complicated form of today’s smart contracts is Decentralized Autonomous Organizations (DAOs) (Çekin, 2019).

Figure 2: How Does a Smart Contract Work?

By the development of cryptocurrencies, blockchain protocols and smart contracts, legal systems around the world are going to be shaped again. Legislations have to adapt themselves to these new technologies and regulate them by reducing their harmful effects. The pioneer areas of law system that are going to be affected by cryptocurrencies and blockchain are: monetary law, law of obligations, law of negotiable instruments and law of property.

Effects on Monetary Law

During the 20th century and beginning of millennium era, the financial system based on fiat currencies and printed monies was used in almost every country. These currencies are issued by the central banks around the world (Demertzis and Efstathiou, 2018). Today’s official currencies are ruled by governments and secured by the assets as gold (the Gold Standard in the monetary system). They have a sovereignty to stabilize economy, boost growth, control inflation and maintain fiscal balances. In order to do so, they use liquidity, interest rate and security deposits. Moreover, official currencies are supported by law and court of justice as well. Nevertheless, cryptocurrencies are not under the monopoly of a central bank or a government—they are controlled by random players around the world (Sapovadia, 2015). There are two features which characterize successful currencies in financial markets: price stability and high number of users (Gregory et. al., 2018). Both of these points demonstrate that their values are based on speculations. The lack of an authority behind these monetary units causes a lack of algorithm for the decision making process (Demertzis and Efstathiou, 2018). In addition, they are not binding to any legal system of any country.

Cryptocurrency markets around the world have a huge impact on economy. Thus, these non-binding monetary units to any legal system around the world have to be regulated with a common way in different states. However, right now, there are diverse views and legislations in different countries and regions. For instance, in USA, states as Massachusetts, California, Florida and Texas have rejected to accept cryptocurrencies as monetary units and they define them as neither legal nor illegal. Differently from these states, New York administration accepted Bitcoin as a transaction method and created a BitLicense for customers and merchants to accept Bitcoin as a payment method (Sapovadia, 2015). Also under EU regulations, it is expected that cryptocurrencies are going to be accepted as securities (Hacker and Thomale, 2018).

Figure 3: Types of Monies.

Effects on Law of Obligations

Law of obligations is the basis of private law system in whole places around the world, and different countries have different legislations about them. On the other hand, there are also common principles of law of obligations which are accepted everywhere and cryptocurrencies have potential to shape these basic principles again. Civil liability to the relevant legal system is a guarantee for the subjective rights and obligations of the parties of the deal. The violation of the civil liability means the violation of the civil law. We face this situation on contractual relationships (Drozd et. al., 2017). Civil liability is a complex implementation: claims and then evidence have to be proved by the courts. However, we cannot say that smart contract relations and cryptocurrencies are reflected by civil liability. Thus, there are not linked to any legal system, they are regulated by their white papers (the paper which demonstrates the rules of relevant blockchain protocol).

According to the general principles of law of obligations, intention is extremely important, and it feeds into the process before the creation of the contract and after the fulfillment of the agreement (Çekin, 2019). During the fulfillment of the contract, intentions have to be matched between parties and if this fulfillment is breached by the authority of state, some restrictions and applications can be enforced. Despite that, by the application of artificial intelligence and autonomous processes in smart contracts, this intention becomes less important, and it needs some revolutions in universal law of obligations (Çekin, 2019). The first part—which has to be adapted to smart contracts—is the issue of defective intention. There can be situations of being mistaken as a result of the obliger’s decisions and declarations or the situations of failure caused by third parties. By a smart contract and transaction of cryptocurrencies, this transactions are recorded on the blockchain and after this step it is impossible to change this record technically. As a result of the situation of being mistaken, relevant transactions have to be canceled in today’s law of obligation systems. However, doing that is impossible in blockchain systems and smart contracts. Therefore, new ways to solve mistakes have to be find for the transaction of cryptocurrencies. The second situation is the obstacles to satisfy the debt. In conditions as impossibility, debtors and creditors can face this problem and the contract has to be changed in here. Nonetheless, it is impossible to do that for a smart contract and new ways have to be found, as well as how these obstacles can be demonstrated in blockchain protocol legally (Çekin, 2019).

Effects on Negotiable Instruments

Electronic monies are monetary units that can be transacted with electronic methods. Electronic monies are electronic types of today's currencies such as electronic Euro, electronic Dollar or electronic Turkish Lira. They are centralized and controlled by central banks. On the contrary, cryptocurrencies are decentralized currencies and they cannot be ruled by states, neither considered a tool of capital market or security instrument (Turanboy, 2019). Also, they cannot be transacted via official transaction methods such as money order or Swap. That said, cryptocurrencies shouldn’t be confused with electronic monies.

Figure 4: Types of Negotiable Instruments.

Negotiable instruments are transactions tools that are used around the world. They represent rights of claims and obligations. They are extremely important in the commercial system and they prove the commercial transactions. There are several types of negotiable instruments: cheques, bills of exchanges, bonds, conversions, etc. (MDM Law, 2023). By the development of electronic payment methods, traditional negotiable instruments have started to become old style. For instance, in Europe, electronic payment systems have been created and, therefore, money can be stored and printed electronically. In today’s world, these instruments can be used via electronic signatures in digital world. In other words, electronic endorsements are applicable (Turanboy, 2019).

By the development and popularization of electronic monies, negotiable instruments started to be less important. If cryptocurrencies are going to be more popular in the future, these instruments are clearly going to lose much more value. They act as a third-party tool to represent a right or value. According to the current banking system, deposits and these instruments are matched with currencies, and they can be easily interviewed (Gregory et. al., 2018). However, for the transaction of cryptocurrencies and structure of smart contracts, this match and representation is made directly and no tool or instrument as those are vital. For that reason, negotiable instruments are not going to be necessary in a decentralized world.

Figure 5: Symbols of Five Most Valuable Crypto Monetary Units.

Effects on Law of Property

By the development of digital technologies, the content stored in digital environment are starting to be counted as a property. They have an economic value, they have an effect on daily lives and their non-physical existence has no importance. These are the main reasons why these intangible assets can be counted as properties (Turanboy, 2019). Cryptocurrencies can be linked to the basic requirements of properties: they have values and they can function as a medium of exchange. In other words, cryptocurrencies have whole conditions in order to be accepted as property. If cryptocurrencies are accepted as properties, the relevant measures to protect and recover a property would be available (Low and Tan, 2020). As a result of the points mentioned above, cryptocurrencies available today are not yet a money for economic transactions, they are seen as speculative assets, and they are counted as speculative assets for capital gains in lots of countries. Thus, high volatility of cryptocurrencies causes a limited use of them and they are targeted as speculation. That's why these high volatility currencies cannot be accepted as monetary units in several countries (Gregory et. al., 2018). It is a condition which is clearly against the main aim of cryptocurrencies and basic needs of monetary law. Without cryptocurrencies, there is no monetary unit around the world which is accepted as both money and property. Therefore, necessary universal legislation has to be accepted by states for cryptocurrencies to be counted as money or property.

Conclusion

Cryptocurrencies and decentralized systems are technologies being studied by experts since the 1980s and, after the economic crisis of 2018, they became extremely popular around the world. They are born to reduce the centralization of monetary units and to secure the trust on financial system. The basis of cryptocurrencies is the technology of blockchain, the decentralized ledger. In addition, their transactions are made by smart contracts which can be functioned automatically, without human intervention. All of these points are going to cause huge changes in global legal system. For monetary law, the role of central banks to control money is going to be changed. Also in law of obligations, the need to delete or return the transactions is an issue that has to be regulated. Negotiable instruments are going to disappear totally and finally, the term of property is going to be redefined.

Bibliographic References

Buterin, V. (2014). A next-generation smart contract and decentralized application platform. white paper, 3(37), 2-1.

Claeys, G., Demertzis, M., & Efstathiou, K. (2018). Cryptocurrencies and monetary policy (No. 2018/10). Bruegel Policy Contribution.

Çekin, M. S. (2019). Borçlar Hukuku ile Veri Koruma Hukuku Açısından Blockchain Teknolojisi ve Akıllı Sözleşmeler: Hukuk Düzenimizde Bir Paradigma Değişimine Gerek Var mı?. İstanbul Hukuk Mecmuası, 77(1), 315-341.

Drozd, O., Lazur, Y., & Serbin, R. (2017). Theoretical and legal perspective on certain types of legal liability in cryptocurrency relations. Baltic Journal of Economic Studies, 3(5), 221-228.

Hacker, P., & Thomale, C. (2018). Crypto-securities regulation: ICOs, token sales and cryptocurrencies under EU financial law. European Company and Financial Law Review, 15(4), 645-696.

Low, G., & Tan, T. (2020). Cryptocurrency–Is It Property?. Journal of Investment Compliance, 21(2/3), 175-179.

MDM Law Firm. (2023, May 29). What Are Negotiable Instruments?. https://mdmhukuk.com/kiymetli-evrak-nedir-cesitleri-nelerdir/.

Nakamoto, S. (2008). Bitcoin: A peer-to-peer electronic cash system. Decentralized business review, 21260.

Sapovadia, V. (2015). Legal issues in cryptocurrency. In Handbook of Digital Currency (pp. 253-266). Academic Press.

Turanboy, A. (2019). Kripto Paraların Ortaya Çıkmaları ve Hukuki Nitelikleri. Banking & Commercial Law Journal/Banka ve Ticaret Hukuk Dergisi, 35(3).

Visual References

Cover Image: ‘Korean Law Firm Fights Back Against Govt’s Crypto Trading Regulation’. newsbtc.com. https://www.newsbtc.com/news/bitcoin/korean-law-firm-fights-back-governments-cryptocurrency-trading-regulation/

Figure 1: Nakamoto, S. (2008). Bitcoin: A peer-to-peer electronic cash system. Decentralized business review, 21260.

Figure 2: 'How Does A Smart Contract Work?'. DCXLearn.com. https://dcxlearn.com/guide/smart-contracts/

Figure 3: Claeys, G., Demertzis, M., & Efstathiou, K. (2018). Cryptocurrencies and monetary policy (No. 2018/10). Bruegel Policy Contribution.

Figure 4: 'Negotiable Instruments: Definition, Types, and Examples'. Javapoint.com. https://www.javatpoint.com/negotiable-instrument

Figure 5: 'Cryptocurrency Regulations Around the World'. Investopedia.com. https://www.investopedia.com/cryptocurrency-regulations-around-the-world-5202122