Closing The Loop

Bitcoin skyrocketed past a record-breaking $18,000-per-coin valuation last week, more than doubling its value in two weeks. But if you were trying to join the cryptocurrency gold rush, you might have encountered some delay. It can take days to complete a bitcoin purchase, and a rush of traffic has slowed transactions in a host of digital currencies, from bitcoin to “CryptoKitties.”

A technology that could speed up those transactions, however, remains controversial and, according to some commentators, could pose legal problems. SegWit2x, a technological framework designed to accelerate bitcoin transaction speeds, could theoretically open up the door to payment security issues that could enable cybercriminals to illegally reroute money from buyer accounts to seller accounts. Segregated Witness (SegWit) technology has also caused a stir in legal circles.

It started after an attorney from nChain, a blockchain research and development firm, posted an article on cryptocurrency news site CoinDesk. Former Davis Wright Tremaine partner Jimmy Nguyen, then-CLO and now current CEO of nChain, argued that segregated witness technology could complicate e-signature laws by making it more difficult to track activities such as assent and agreement. Attorneys from a number of law firms, however, attacked the lawyer’s opinions, believing that he was conflating a number of different legal concepts and that he was driven more by the need to market his product than by pure legal logic.

So, are the purported legal issues surrounding segregated witness really worthy of all the controversy and hype? Let’s take a closer look to see whether this is the case.

 

Segregated Witness Technology Explained

Understanding SegWit first requires some understanding about how bitcoin works. All pending bitcoin sales are organized into self-contained packets of data called “blocks.” These blocks each contain information about multiple pending transactions such as anonymized buyer and seller information and sales data, and are submitted for inclusion into bitcoin’s encrypted distributed ledger, the blockchain. Bitcoin’s distributed blockchain ledger tracks all transactions involving the cryptocurrency going back to the first-ever bitcoin transaction, and does so without the involvement of a bank or other centralized institution.

When transactions are submitted for inclusion into the blockchain, they contain packets of information about the transaction—including “witness” data, which is used to unlock and release all bitcoins the buyer decided to spend so that they could be transferred from the buyer’s wallet to the seller’s wallet. Originally, this encrypted witness data was placed within the overall processing code describing the transaction.

This meant that bitcoin’s blockchain ledger needed to fully decrypt all of the contents it received about the transaction before fully processing and recording it into the blockchain.

Segregated Witness (SegWit) resolves this by separating—or “segregating”—the witness data away from the transaction data, which allows bitcoin’s blockchain to fully read and record the details of the transaction before releasing any actual bitcoins.

Because the decryption process was saved for the very end, SegWit has played a major role in speeding up bitcoin transactions by allowing bitcoin’s blockchain to record transaction IDs without needing to decrypt and unlock bitcoins in the process.

In doing so, however, SegWit doesn’t include the witness data on the blockchain—including so-called “signature data” which verifies that both the buyer and seller agreed to enter into the specific bitcoin transaction. It’s this aspect of SegWit that’s been generating recent controversy.

 

What All the Fuss About SegWit is About

Nguyen first person to critically attack SegWit on the legal grounds. In an opinion piece that he submitted to the cryptocurrency news website CoinDesk, he argues that because SegWit stores witness data off the blockchain and opens up the possibility of even discarding it depending on whether the digital wallets involved support SegWit, it would be impossible to verify some transactions as valid should they ever come under dispute.

Because this signature data is usually dropped after the transaction is validated and added onto the blockchain, Nguyen argues that the best a deprived party can do is find the matching hash values proving the transaction occurred.

But even this hash-based data won’t rise to the level of an e-signature, since the hash data wouldn’t necessarily reflect that the parties’ intended to enter into the transaction—much like the signature data stored in the witness blocks would.

Because of this, Nguyen states that SegWit’s focus on authenticating transaction data over authenticating the witness data will lead to enforcement issues down the road when parties try to find evidence relating to disputed transactions.

After it was published, many bitcoin legal experts came out against Nguyen’s position. The main critique behind Nguyen’s piece, put forth by Cooley’s Marco Santorini and Anderson Kill’s Stephen Palley, was that Nguyen mistakenly treated bitcoin signature data and contract e-signatures as the same thing. Instead, they stated that the signature data was designed to facilitate transaction processing, and not necessarily serve any legal purpose.

Other legal experts suggested that the integrity of the blockchain itself—which is designed to include only valid, approved transactions that would have needed valid signature keys in order to be added—should be sufficiently sound enough to resolve any intent issues arising from disputed transactions, making Nguyen’s concerns moot.

Still others claimed that the opinion piece had an underlying ulterior motive to promote nChain’s services, although CoinDesk’s editors noted that their company was owned by Digital Currency Group, which helped spearhead this summer’s SegWit soft fork.

Whether SegWit or SegWit-like technology will soon impact the way we process and understand e-signed contracts remains to be seen. That being said, it serves as a sign of the exciting, if frustrating, legal issues that could arise from blockchain—especially as companies are starting to explore patenting blockchain-based processes and systems that go beyond cryptocurrency transactions. And it only underscores why lawyers should continue to focus on the possible eDiscovery issues arising from blockchain-based technologies.

Want more information on the future of cryptocurrencies and the legal system? Join us for Logikcull’s webinar on “Bitcoin, Blockchain, and the Law,” featuring Erica G. Wilson, of Vuono & Gray, and Stephen T. Middlebrook, of Womble Carlyle.

This post was authored by Eric Pesale, an attorney who writes about eDiscovery, cybersecurity and other legal topics for law firms, publications, and companies. He is the founder of Write For Law, and is a graduate of New York Law School and the University of North Carolina at Chapel Hill. Eric can be reached at eric@writeforlaw.com or on Twitter at @writeforlaw. 

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