Fork Law Meditations: Part 1

Some Groundwork on Blockchain Property Rights

tldr: there are four main kinds of property-ish legal rights associated with blockchains that are especially interesting to think about in the context of forks: (1) token ownership, (2) smart contract ownership, (3) network ownership and (4) protocol ownership; we discuss the intuitions behind these as preparation for covering interesting legal issues related to blockchain forks and related governance issues

Intro

I hereby unceremoniously begin part 1 of my n-part series of meditations on ‘the law of blockchain forks’. Buckle up, it’ll be a bumpy ride!

The first thing I think we need to tackle this subject coherently is some background and context on how property rights apply to blockchains. I am going to approach this very un-scientifically. This is not intended to be a scholarly work on property rights—instead, I’m going to lean mostly on intuition pumps and policy concerns. The point is not to analyze property law, but to put some basic premises in place so we can move onto much more interesting topics relating to forks, governance and related legal issues.

Token Ownership

I don’t consider it controversial* to claim that people have property rights associated with digital assets—tokens, coins, cryptocurrencies, etc.—on a public read/write-unpermissioned blockchain maintained through a peer-to-peer open network. Put simply, in my opinion, someone who buys some BTC or ETH in a voluntary exchange for fiat or another digital asset ordinarily acquires ownership of some type of asset typically referred to as “BTC” or “ETH”.* This also conforms with (most of our) intuitions. For example, if miners reorged my tokens from ‘my wallet’ (please forgive the barbarous ‘wallet’ simplification) to their wallet—I would consider that (and believe most other people would consider that) a theft of my tokens.

Smart Contract Ownership

But what about something other than tokens—like a “smart contract” (i.e., some executable bytecode tied to a blockchain address)? Does anyone “own” that? If not, do they have other kinds of “property-ish” rights in the smart contract—such as the right to remedies if the smart contract is “hacked” or suffers ‘torts’ (legal wrongs, like trespass or conversion)? If such property-ish rights to a smart contract exist, do they belong to the initial deployer of the smart contract? What if the smart contract is tied to a ‘governance token’—do the holders of the governance token then have such property-ish rights in the smart contract? What about the community of users?

I think it depends on what you mean by the word “smart contract.” The bytecode and source code for the smart contract are typically free open-source software. It would be irrational and wrong to suggest that a mere copier/deployer/user of such software has property-ish rights in it—on the contrary, they have a mere use right.

But there is a different sense of the term “smart contract” in which what is meant by “smart contract” is really something different from both the bytecode that is deployed to Ethereum and the source code for that bytecode. The “smart contract” in this sense is the bytecode/software as deployed to and used at a specific Ethereum address—i.e., it relates to a specific deployed instance of the bytecode. The deployer or community surrounding such a specific instance confers unique value to it separate from the bytecode itself—network effects, branding, marketing, etc. The value they invest in that specific instance of the bytecode and their reliance on it raises the stakes and ought to be seen as transmuting it from a mere copy of mere code into something like a public good comparable to a national park or infrastructure or a community good comparable to the land in a gated community. In this sense of the word “smart contract,” it seems to me at least conceivable that the law could (and perhaps should) recognize property-ish rights of deployers, users and governors of smart contracts, even though the code is free and open source.

Network Ownership

In the past I have argued that many tokens can be usefully viewed as shares of network equity. A quicker/dirtier version of those arguments might go something like this:

Many tokens are designed or expected to increase in value as the network effects for that network grow—i.e., as user adoption, user stickiness, integration with legacy systems & etc. increase. This means that the token holders share in the value of the network in a manner intuitively similar to the manner in which shareholders share in the equity value of a corporation—except through mechanisms of game theory, code and social custom rather than through law and contracts. This makes it useful to think of tokenholders as owning a stake in the relevant network and most long-term tokenholders do in fact think of themselves in roughly this way.

Of course, owning a ‘share of network equity’ is very different from owning a fractional interest in the software that network is built on—what we might call a ‘share of protocol equity.’ The ‘ethereum protocol’ (the software Ethereum is built on) is free open source software: I have no ownership rights in it, and anyone can do anything they want with it without respecting my ownership of ETH on the particular instance of the protocol known as Ethereum. Thus, if I own some percentage of all ETH and we assume that someone uses the Ethereum protocol to deploy a new public or private blockchain/blockchain network—call that blockchain network bizarroThereum and its native token bizarroETH—ordinarily my ETH ownership gives me no rational expectation or right to receive bizarroETH.

On the other hand, if someone fucks with Ethereum itself—for example, if a world superpower hordes GPUs and launches a massive consensus attack or DoS attack on Ethereum—at that point my reaction will be different: I will likely be angry and feel that my rights (especially my property rights) are being violated —my ‘share of the network equity of Ethereum’ is being trespassed on, stolen or vandalized. Based on this intuitive distinction and our natural reactions, we can, like with smart contracts, envision that the law could recognize some type of property-ish rights in a blockchain network—for example, if the attacking country were China, it is not outlandish to think that the U.S. might, on behalf of its citizens who hold ETH, claim that China’s consensus attack violated international law, and seek justice in the Hague or deem China’s act a declaration of cyberwar.*

Protocol Ownership

Above we observed that ordinarily blockchain protocols are free open-source software and tokenholders have no expectation or sentiment that they will be vested in property-ish rights in such protocols. There is one noteworthy exception to this which many readers might not be familiar with—the expectations of venture capital investors that they have continuing property-ish rights in the protocols they helped to fund. In a phenomenon both strange and disturbing, large venture capital investors who are active in funding blockchain development companies now regularly take the position that they are ”investing in the protocol,” not merely the tokens associated with the network and not merely the equity of the development company.

Now I really want to emphasize the strained nature of this position. Most blockchain protocols are—and basically need to be—free open source software. We are not talking about investing in an enterprise software company. And even when VCs do invest in companies with a proprietary software model, it’s not like they normally also negotiate for a direct ownership stake in that software—rather, they merely take an equity interest in the corporation, which is the legal owner of the software. Nevertheless, when investing in blockchain development companies, VCs currently take a different view unique to that context—i.e., they believe they must receive a direct quasi-ownership right in the ‘blockchain protocol’.

How does this work? Well—confusingly, of course! It’s a squaring-the-circle exercise if ever there was one, and I personally find it worrisome in ways I won’t get into here. But the basic idea is that a blockchain project’s VCs will get both the development company and the key protocol developers—the ‘protocol founders,’ as it were—to sign agreements promising that the investors will receive a fixed percentage of tokens on every new instance of the protocol (other than obviously value-less instances like testnets). Although this promise cannot always be fulfilled (and if the founders have a good lawyer, the deal will likely be negotiated down to a version that only covers the situations the founders can actually influence), what these agreements accomplish is to get the investors as close as possible with blockchain protocol software to the investment thesis they have for proprietary software. In effect, through side-agreements with the key people who are most likely to create valuable forks or valuable new instances of the blockchain protocol, the investors create for themselves something roughly like a ‘share of protocol equity’. So if Ethereum had been invested in on this type of basis with investors getting 10% of ETH, and then Vitalik was involved with creating bizarroThereum, the investors would also get 10% of bizarroETH, even if they had already sold a bunch of their regular ETH.

Thus, unlike ordinary tokenholders, these investors will have both a share of network equity (through token ownership) and a share of protocol equity (through legal agreements). And just as we can imagine that the law might respect property-ish rights in network equity, a fortiori, the law should respect the VCs’ property-ish rights in the protocol arising from these bespoke legal agreements.

Conclusion

In summary, there are four main kinds of property-ish legal rights that are interesting to think about in connection with blockchain forks: (1) token ownership, (2) smart contract ownership, (3) network ownership and (4) protocol ownership. Each of these can be affected in different ways by blockchain forks, and we’ll take these ownership rights concepts and use them to explore the legal issues relating to blockchain forks and governance through the rest of this n-parted series.

*Endnotes

1. But, for a contrarian view on whether property rights apply to tokens, see Matthias Lehmann, Who Owns Bitcoin? Private Law Facing the Blockchain, 21 MINN. J.L. SCI. & TECH. 93 (2019) (arguing that “property law is anathema” to “blockchain enthusiasts” and that lawyers should accordingly analyze blockchain disputes without reference to property law).

2. Exactly what that asset is, whether the nature of the asset differs depending on whether the protocol uses a UTXO model or account model, etc., are not issues I will deal with here. I also will not deal here with various other nuances. For example, crypto ownership issues get complicated in intermediated acquisition contexts, such as centralized exchanges where BTC and ETH are sold and custodied on behalf of users—maybe the central exchange user really just owns a claim against the exchange for BTC and ETH, not the BTC and ETH itself? At least one court (the New Zealand High Court) has held that users do have property ownership rights in custodied cryptocurrencies (see my summary of the Cryptopia bankruptcy case). The waters are also muddy when it comes to acquisitions of crypto that might violate the law in some broader way—e.g. where one party is using stolen money to fund the purchase of tokens from an innocent party (see Matthias op. cit.).

3. Of course, it is indeed interesting to think about the fact that we would have non-legal defenses against such an attack—e.g., changing the PoW algorithm and reorging back to the pre-attack state via a hardfork. But such a remedy might not always be adequate—the attack might have resulted in a massive price drop in ETH and ETH might not fully rapidly recover that price on the new fork. Markets are not completely rational. Much other collateral damage might also ensue on a case-by-case basis and people might wish to lean on their property-ish legal rights through the court system to seek remedies for their damages in these more idiosyncratic disputes.