How to Cope with Block Chain Legal Liability

Some institutions may hesitate to participate with a blockchain until they get assurance on potential liability.

Bitcoin Is Just One Example of an Explosive Idea.


Bitcoin’s blockchain is a specific example of a greater idea. It is a distributed ledger. A distributed ledger is a powerful innovation for accounting.
debit credit
Traditional Central Ledger
It replaces the traditional centralized ledger for keeping track of trades and ownership of assets, such as money, stocks, barter, commodities and more.

The centralized ledger requires a central authority like a bank to keep track of debits, credits or other matters of account.

In contrast, a distributed ledger manages debits and credits by community action. In Bitcoin, the members of this community, this “crowd,” are called miners. They perform calculations and confirm transactions publicly, such that all the participants can observe what is happening and verify accuracy.

The distributed system does not rely on a central authority, who can be corrupted.

Bitcoin’s blockchain is the first really successful application of a distributed ledger. But visionaries see much more for the future.

A Better Way to Administer Trust


In effect a distributed ledger is a method for managing trust among entities without requiring the entities constantly to check back with headquarters (the central authority) to confirm that an entity or party is entitled to a measure of trust. Checking back with headquarters for every transaction is inefficient.

Checking with the crowd that maintains the block chain (the miners) can be more efficient.

What is even more important is this: to corrupt a large crowd of miners is harder than to corrupt a central authority.

An Open Ledger Manages Trust.


Therefore IBM is exploring use of block chain to manage trust in the Internet of Things, where a multitude of devices (like your smart watch and your home thermostat) share data and responsibility with one another.

An example Internet-of-Things transaction might be the decision for a thermostat to trust an instruction from a certain smart watch to increase temperature by three degrees at 2:03 p.m. The confirmation of transactions might be distributed across a large and constantly evolving multitude of devices (a crowd). No single device is trusted too much. But the system can function if most of the devices are trustworthy most of the time.

Confirmation of any unit of trust [see footnote] comes from multiple miners in the crowd, but not necessarily all the miners.

Potential Liability for Errors or Omissions


Bitcoin’s block chain runs on open source software. Many people have contributed to its development and updating.

[Video above depicts action on Bitcoin's block chain through bitcointicker.co; video saluted by @BTCticker.]

Many distributed ledger projects will involve the collaborative efforts of many parties.

However, some institutions (like a large nonprofit foundation) will be concerned about the potential liability that comes from associating themselves with a block chain project. Their contribution might look like an endorsement or an acceptance of responsibility.

Block chains will not always work as expected. For instance, Bitcoin as originally designed has proven vulnerable to attack in that hackers can steal bitcoin from an individual trader if they can compromise the credentials for a trader’s single signature. For that reason Bitcoin is evolving to multiple-signature credentials.

In the future, as a new blockchain is created an institution that supports it would not want to be a “deep pocket” target for a lawsuit from someone who claims the block chain’s poor design caused damage. (Example case: member banks settle liability for actions of electronic mortgage clearinghouse.)

Warn Users of Risk.


For this reason institutions are wise to insist that the block chains they support come with disclaimers and/or terms of use. These types of statements can explain and disclaim risk.

For instance, something like the following statement might be published widely in connection with a block chain that manages ownership among stockholders of a corporation:

This block chain is offered "as-is" with no assurance of reliability. Use at your own risk. 

The statement might go on to explain with some detail the kinds of risks that are present, such as flaws in software or a future decrease in miner incentive to work.

A disclaimer is not a perfect shield from legal liability. It probably does not protect an institution from liability if the institution knowingly engaged in fraud. But a well-crafted disclaimer can dramatically reduce the risk of liability.

Example Disclaimers


Here are three examples of institutions insisting on the publication of disclaimers relative to their contributions to community projects.

  1. The payment card community works together to publish the Payment Card Industry Data Security Standard. The PCIDSS sets standards for securing credit card data. However, it is possible that a merchant who follows PCIDSS will still suffer a data breach. The institutions that participate in the PCI community and promote the PCIDSS desire no liability for a shortcoming in the standard. Their solution is to require anyone downloading a copy of the standard to agree to a contract that disclaims liability and places risk with the user merchant.
  2. The American Medical Association works with the National Supplier Clearinghouse to facilitate communications of Medicare claims by healthcare providers. However, the methods and technology of the Clearinghouse may not give a healthcare provider the desired outcome. AMA wants no liability. Therefore access to the Clearinghouse website requires the user to click on terms that disclaim liability by AMA.
  3. Ethereum.org publishes this statement regarding the initial sale of "Ether": 
Ether is a product, NOT a security or investment offering. Ether is simply a token useful for paying transaction fees or building or purchasing decentralized application services on the Ethereum platform; it does not give you voting rights over anything, and we make no guarantees of its future value.

What Stands in the Place of Legal Liability?


The user of a block chain that comes with a disclaimer might ask how he can get assurance if legal liability has been disclaimed. The answer is that the user can rely on “collective intelligence.” The user can observe the collective behavior of the community using the block chain to understand the risk associated with it. If a large and smart community is using the block chain in a transparent way, then the user can sense a measure of assurance, though he knows he probably cannot use the legal system to enforce that assurance.

Cyber Insurance Distributes Risk.


Another way to manage risk is to acquire insurance. Some block chains may require participants to pay a fee, part of which could goes to the purchase of cyber insurance to cover the participants for risk of loss.

Alternatively the terms of a block chain might require that each participant purchase certain insurance for itself and absolve all other participants of liability.

Hold Harmless Clause Assigns Risk and Incentives.


The absolution of liability might be worded different ways, depending on the needs and culture of the community. For instance, an absolution of liability might include:

  1. An indemnification clause in which each participant holds each other participant harmless from any claims based on the first participant’s reliance.
  2. A caveat that the absolution of liability does not apply to intentional fraud, which is proven beyond a reasonable doubt. Such a caveat sets up a high standard of evidence that a participant must meet in order to collect from others on account of their misdeeds.


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Footnote: The “unit of trust” might measure any number of things. In Bitcoin it measures a debit or credit of bitcoin. But the unit of trust could measure ownership of land or commodities. It could even measure community perception on whether an entity or individual professional is in compliance with law, ethical principles or industry standards.

Related:

  1. Declaration of entire crypto 2.0 project as "as-is" and "use at your own risk" 
  2. Recording Bitcoin Legal Evidence