Blockchain Could Revolutionize Corporate Law, Geis Says
Blockchain, the technology underlying bitcoin transactions, could revolutionize financial markets and corporate law, says University of Virginia School of Law professor George Geis.
Geis, the William S. Potter Professor of Law and Thomas F. Bergin Teaching Professor of Law, explains in a new paper the impact blockchains could have on tracing shares, shareholder lawsuits, corporate governance and shareholder responsibility.
Blockchains are used to create digital, publicly available — yet tamper-proof — ledgers of past transactions for a given bitcoin.
During a recent talk at the Law School, he said the technology, if applied in traditional stock markets, could transform trading by providing investors with detailed information regarding a share’s past owners.
He provided some theoretical impacts of this development on corporate law, such as a potential theory of liability based on historical ownership of shares that have since been sold.
Geis said his interest in blockchain was prompted by a student that introduced him to bitcoin years ago.
“[The student] said, ‘It’s this really neat cybercurrency that’s been created by computer programmers in a way that’s completely uncoupled from any state activity and that’s not backed by anything other than trust that the currency will be worth something,’” Geis said.
At the time, this sounded like a dubious proposition, so Geis declined to invest in the fledgling currency. He then watched the value of bitcoin spike over the next few years.
“If I had set aside $10,000 back then, when the student first approached me, I would now be $45 million richer,” he said. “It’s hard to ignore these types of topics.”
Geis’ academic interest soon settled on the blockchain technology undergirding bitcoin transactions, rather than the bitcoins themselves.
To understand how blockchain could affect markets, Geis sketched out the history of stock transactions.
In the first half of the 1900s, “buying and selling a share of stock looked a lot like buying and selling a used car,” Geis said. When corporations issued stock, they would issue physical certificates to their shareholders, similar to car titles.
When they sold their shares, shareholders would send the certificate of ownership to the buyer so that the buyer had legal verification that the share had changed hands.
The buyer then would send this paperwork in to the corporation, so that the corporation could keep track of its share ownership.
“We might call this stock settlement version 1.0,” Geis said.
In the 1960s, as trading volume increased, the system became unwieldy due to its reliance on cumbersome paperwork. Congress, the Securities and Exchange Commission and Wall Street settled on a fix for this problem, creating the stock clearance system used today. American firms issue stock to a centralized entity called the Depository Trust & Clearing Corp., which remains the formal holder of the shares.
Specific shares are not identified as the ones that have been traded. Shareholders are accounted for as owners of a proportion of shares, not specific shares with distinct transaction histories.
When a shareholder decides to sell, they no longer must transfer a physical certificate. They simply contact DTCC — usually through a broker — and the transaction is completed through an accounting adjustment at DTCC and the brokerage. This allows for a far greater volume of trades than under the old certificate system.
This system, while more efficient, still has problems from a corporate law perspective, Geis said.
“Every time a company wants to hold a vote, say for annual director elections, we’ve got to work up and down through these various intermediaries trying to figure out who actually has the right to vote,” he said. “Sometimes there are even mistakes. There are a number of instances where more stock has been voted than exists in the entire world.”
Geis also noted that sometimes a shareholder needs to know whether the specific shares they own qualify for certain rights. This is often impossible to determine.
Geis then explained how blockchain — or distributed ledgers — works, and how it could be used to address some of the stock clearance system’s legal weaknesses.
“In a nutshell, we can view a distributed ledger as just being another form of tracking ownership information about an asset over time,” Geis said.
Historically, asset ownership is determined through general ledgers maintained by accountants working for corporations. General ledgers provide information about what a corporation currently owns, but they don’t always include detailed histories of each individual asset’s history prior to coming under its current ownership.
Unlike general ledgers, distributed ledgers update the ownership history of a given asset in real time.
“You can think of this like a real property recording system, where there are thousands of individual participants, each of whom might have the right to modify the records and then, once the modification takes place, these rights are broadcast and mirrored throughout all the industry participants,” Geis said. “You don’t have to go down to a dusty government office and look at who the history of owners are, you can just look at your computer system and try to figure it out.”
The integrity of the distributed ledger is maintained through blockchain technology, which was developed to maintain bitcoin’s transactional integrity but can theoretically be applied to any system of asset distribution.
When a bitcoin transaction takes place, the seller exchanges online information with the buyer. The public is then notified of the transaction. That transaction constitutes the most recent block on the blockchain.
Members of the public known as bitcoin miners then facilitate the transaction.
The miners receive information about transactions that are ready to be processed. They then compete to solve an algorithmically generated puzzle. To solve the puzzle, the miners must find a variable number that, when added to the rest of the data related to the transaction at issue, completes the transaction.
A block containing all the data relevant to the recent transaction — including the mined variable — will then be permanently linked to all the previous blocks in the specific bitcoin’s history — or chain.
“What we’re generally doing here is we’re creating a historical string akin to property ownership where we can see who’s been the owner of this property over a long period of time,” Geis said.
The technology could lead to a new form of stock clearance he called “traceable shares.”
Using a distributed ledger, “we could now look back and have perfect historical provenance over who had owned any specific share of stock over any period of time,” Geis said.
If blockchain were used to clear stock transactions, this could simplify the process of determining shareholder rights that depend on owning specific shares of stock.
Blockchain stock clearance could also give rise to new complications.
“It’s not inconceivable that we would see fragmented trading markets for stock,” Geis said. “If I want to exercise a certain legal claim and only a subset of shares are going to qualify for that claim, I may call my broker and say, ‘I want to buy shares of a firm but only shares that allow me to sue them for this Section 11 violation.’ I think we may see trading markets become bifurcated or trifurcated.”
“I think the availability of traceable shares would allow us to begin to ask really interesting questions about the locus of corporate liability,” Geis said.
Currently, liability is usually assessed to the current corporate entity, even for misdeeds that occurred long before some current shareholders had purchased stock in the company.
Geis said that with traceable shares, it was theoretically possible to go to the distributed ledger and assess liability to shareholders who owned stock at the time of a misdeed and had subsequently sold their shares.
Geis did not say that this should necessarily be done, but he acknowledged that it would be possible.
He added that, though blockchain-based stock markets may sound speculative, some companies are already moving their stock over to distributed ledgers.
“This really is an important and an interesting area for business lawyers to watch over the next few years,” he said.