Blockchain technology and competition law - issues to be considered

1. Blockchain basics

Blockchains[1] are decentralized and distributed databases or ledgers. Decentralization means that the validation of the correct state of the databases takes place by reaching consensus in a decentralized process where decision cannot be dictated one or more centralized actors. The copy of the data (the blockchain") is distributed so that copies of data reside on all the nodes that make up the decentralized network. What is unique about blockchain technology is that nobody is in control of either database or decision making.  

The Bitcoin blockchain is considered to be truly open. Everybody can download the Bitcoin client software and become a node on the Bitcoin network and as a validator participate in the decision to reach consensus on the correct copy of the Bitcoin register. Furthermore, all nodes have full access to the ledger data and this is also available to all users of applications and third party services. Open blockchains are fully transparent, not just with respect to the ledger, but also the underlying computer and the protocol that embeds the consensus mechanism is (almost always) available under an open source license.

An open blockchain with enough nodes to be truly decentralized cannot be altered. Once a new block with entries has been validated and added to the chain the entries are irreversible. And new entries cannot be added, unless the consensus mechanism accepts this. This immutability combined with that the consensus mechanism prevents monopolization of decision making is by many considered the most revolutionary property of blockchain technology. As users of the ledger do not have to trust the integrity of a centralized actor, blockchain technology is referred to a "trustless" technology.

Entries into the blockchain can be simple text. It can also be pieces of computer code that embed contractual terms. Such “smart contracts” are a piece of computer code capable of verifying, executing and enforcing a set of instructions. The computer code reviews a pre-determined set of inputs, matches them against conditions written in the code and allows a transaction to be executed only if all necessary conditions are met. For example, a smart contract installed by a seller can check incoming purchase orders for compliance with the sales contract in the real world and release a batch of products for shipping to the customer if the purchase order matches the terms of sale agreed with that purchaser.

Smart contracts can work automatically without any other input for humans than the initial coding and the decision to enter the smart contract on a ledger. Once it is uploaded it can receive the information needed to have its condition trigger automatically (self-sufficiency). On the basis of such information, e.g. that occurrence of a set date and time, it can automatically execute it terms, e.g. send a purchase order (self-execution). Finally, if the smart contract calls for consequences, such as if the other party does not comply with the terms, e.g. that the money is not transferred to an account at the agreed time, it can automatically trigger a forced sale of an digital asset (self-enforcement). When these automation properties of smart contracts are combined with the irreversibility of blockchain technology, the "trustless" potential becomes very interesting. 

Open, transparent and immutable blockchains are very interesting and their use cases will be built on new and innovative business models and bring disruption to many industry incumbents. The fact remains, however, that most use cases discussed today are not based on open blockchains. Key properties of open blockchain such as irreversibility and transparency are incompatible with enterprise and government business modus operandi where some degree of confidentiality and error correction is demanded. The regulatory framework of most mature industries demands some control on its actors. In "pure" open blockchain control by single or group of actors is an anathema.

All blockchain technology for enterprise or government attempts to square this circle: How to preserve some of the technological advantages associated with open blockchain while affording its users the control needed to comply with regulation. At the core is to device consensus mechanisms that while still securing non-collusion and tampering gives some way to correct faulty entries and make changes to the ledger considered beneficial to the network. How to preserve data confidentiality while still allowing the data to be distributed on the network? A number of innovative solutions for new types of consensus mechanisms for the non-open but "private" or "permission-based" blockchain are brought to the market constantly. And most legal challenges associated with blockchain technology do in fact deal with the use of private blockchains.             .  

2. How does competition law apply to Blockchain

Most blockchains are likely to be efficiency enhancing and pro-competitive. Decentralization and transparency will promote better functioning markets. The key to understanding blockchain from a competition law point of view is, however, that all information on the blockchain is accessible to everybody within the peer-to-peer network regardless of whether it is open for all or permission-based.

Whilst the information that is held is the entries may be anonymized or encrypted depending on the rules applying to the blockchain, the information nonetheless provides a granular insight into members' commercial transactions at any given time without the customary uncertainty about the veracity of the information. Blockchains can store a range of records including payment transactions, sales records, purchase history, corporate accounts, pricing history as well as future changes to pricing. It can also record non-transactional data such as title records, trademark and patent information, minutes of meetings, calendar entries and travel logs to name but a few. In private blockchains this information will be restricted to those who have been given permission to participate. The information itself may not be visible to all, but all will have access to time stamps of the entries and to the identity of those who entered it (or at least to their digital signatures certificates).

To be truly efficient and reach its full commercial potential blockchains will often be set up in peer-to-peer networks including actual or potential competitors. This unfettered access to potentially commercially sensitive information by competing companies puts blockchain firmly into the crosshairs of competition law enforcement.

Competition law seeks to prohibit restrictions of competition between competitors, whether this comes as a result of some form of agreement or understanding between competitors (caught by e.g. Article 101 of the EU Treaty and national equivalents) or through unilateral conduct by a dominant market player (caught by e.g. Article 101 of the EU Treaty and national equivalents). Assessment of blockchain will likely mostly fall under the first category. The issues faced by competitors setting up or participating in blockchains will most often fall into main categories such as (i) membership rules; (ii) information exchange; (iii) standardization and (iv) rules applicable to JVs, including merger control.

The starting point for competition law analysis is that each company must determine independently the policy which it intends to adopt on the market and the conditions it intends to offer to its customers. Somewhat oversimplified, competition law precludes any direct or indirect contact between competitors that creates conditions of competition which do not correspond to the normal competitive conditions of the market in question unless there are justifiable reasons for such contacts and that the end result is pro-competitive.

2.1 Membership/consortia rules

Particularly when dealing with private blockchains, the competing companies involved will have to consider and work through possible competition law ramifications of the rules governing the blockchain. For open blockchains the governance rules are embedded in code. The blockchain protocol part of the software defines the consensus mechanism. The software protocol also defines the consensus mechanism for private blockchains. However, the governance is always complemented by a "traditional" agreement between the permissioned parties through cooperation agreements, articles of association for companies or other types of organizations such as association, foundations and companies, and in shareholders agreements for the latter.

This is in reality no different than what trade associations are faced with and the issues are to a large extent the same. Indeed, where participation in a particular blockchain is or becomes important for acting on a given market, attempts to exclude a competitor may infringe competition law.

Consequently, there must be reasonable and objective rules for participating in the blockchain which are clearly set out in advance and which are based on objectively justifiable criteria. Enforcement of the governance rules must remain uniform and consistent (e.g. do not play favorites or discriminate against an unusually aggressive competitor) and the rules of procedure must be fair (e.g. ensuring the possibility to exchange points of view and appeal a negative decision).

Likewise, the verification process pushing forward the validation of blockchain transactions will also require scrutiny to ensure that the rules are objective and reasonable. For example, it will be important to avoid that the rules prioritize the clearance of transactions of certain of the members or boycott transactions of other parties. This calls for analysis of the workings and procedures of consensus mechanisms and requires understanding of and access to the underlying software protocol.

2.2 Information exchange

The risk of anticompetitive information exchange between competitors is likely to be the most significant competition law risk. The exchange of data that reduces strategic uncertainty in the market may lead to competition law infringements as it decreases the incentives to compete. Strategic information can be related to, e.g., prices, discounts, increases, reductions or rebates, customer lists, production costs, quantities, turnovers, sales, capacities, qualities, marketing plans, risks, investments. Generally speaking, information related to prices and quantities is the most strategic, followed by information about costs and demand. Exchanges of information about future conduct (or information from which future conduct may be gleaned) carries the highest risk.

Part of the raison d'être of blockchain technology is reaping the efficiencies related to increased transparency. However, such increased transparency and the use of smart contracts may facilitate and/or strengthen anticompetitive collusion and quite some thought need to go into the assessment of whether a particular blockchain may lead to a such risks.

Therefore, companies involved need to be painfully aware of which types of information will be made available through the blockchain and how. It may be necessary to put in a layer of cryptographic protection of certain information to protect particularly commercially sensitive data or even having certain commercially sensitive data off-chain.

This said, not two cases are likely to be identical and the competition law assessment will depend entirely on the particular circumstances of a given blockchain and/or the market(s) it touches. In most cases, it will be possible to obtain the benefits of the blockchain with a low risk of infringing competition law by having the right structure put in place. Or put differently, it is more likely that the relatively more transparent information on a blockchain and the use of open source software will be an argument for more competition and less restriction.

2.3 Standard setting

The primary objective of standardization agreements is the definition of technical or quality requirements that have to be complied with. Achieving a consensus on common technical standards behind a given blockchain is likely to become more and more relevant as interoperability within a system will be key.

However, such agreements may in certain cases reduce or limit competition on price, technical development and innovation and/or create entry barriers. If this is the case, competition law may apply and the blockchain will have to set rules to ensure a compliant functioning of the standardization process.

For example, blockchain members will have to ensure that participation in the rule-setting is not unduly restricted; that the procedure for setting a relevant standard is transparent and that access to the adopted standard is possible on fair, reasonable and non-discriminatory (FRAND) terms. Any restrictions must be shown to be reasonably necessary to allow the blockchain members to achieve the objectives pursued.

2.4 JV and merger control

Setting up cooperation in relation to a blockchain may be subject to careful scrutiny of the pro- and anticompetitive effects of such cooperation and apart from the rules described above there may be other types of analysis needed to ensure that the purpose and goals sought are compliant with the competition rules on horizontal cooperation. This will increasingly be the case, the closer a given blockchain comes to the market, i.e. joint production, joint commercialization and the like. As mention earlier, the terms of cooperation between a group of organisations on a market place enabled by permission-based blockchain technology will be partly embedded in the code part of the consensus mechanism protocol and the smart contracts that run on the blockchain. These terms and their potential anti-competitive cannot be assessed without an understanding of and insight into the software code. 

Whilst it will be very rare, it cannot either be excluded that setting up a blockchain may result in a notifiable merger transaction in certain jurisdictions. If so, this needs to be taken into account at an early stage of the process.

3. Conclusion

Setting up a blockchain is likely to involve direct or indirect cooperation between competitors in varying degrees. Lawrence Lessig stated in his book "Code and Other Laws of Cyberspace" in 1999 that computer code regulates conduct in much the same way that legal code. This is doubly true with respect to smart contracts running on a blockchain. When establishing a private consortia to run a permission-based blockchain the parties should put in the time and effort to analyze whether there are competition law concerns and how they are to be dealt with as this will be crucial to ensuring best practice and avoiding infringement of competition rules. Competition authorities have vast powers of investigation and the consequences of running afoul of competition rules can be extremely onerous.

Paradoxically, an open ledger that holds information about prices and quantities, costs and demand will on the face of it be seen as bringing transparency to a market and therefore as a promoter of more competition while it may at the same time give competitors access to hitherto unavailable data that may enable concerted practices breaching the competition rules. 

Finally, it should be stressed that the application of competition rules is never static. As the cooperation within a given blockchain evolves the factual situation may change, which again may have an impact on the competition law assessment of that particular blockchain.

In other words, regular sanity checks on the operation of the blockchain and the agreements governing whether in the standard it is based on, cooperation agreements, consensus mechanism protocols or code of its smart contracts will be highly advisable.

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[1] The term blockchain comes from the process of adding blocks of cryptographically signed data to form a permanent and unalterable chain of records. Each transaction is assigned a unique set of characters and multiple transactions are lumped together to form a digital block. Each block connects to the immediately preceding block and the immediately subsequent block, thus creating the chain.