The Hard Fork From A Legal Perspective

Posted in: Archive
February 13, 2016 3:18 PM UTC

In a blog post by Daniel Friedberg, principal of the law firm Riddel Willams PS in Seattle, some of the legal ramifications for the hard fork of Bitcoin have been addressed and raise interesting and critical questions about the future of such projects.

The hard fork topic has come to head recently as a vocal and active group of developers has advocated for the change or upgrade of the current platform that Bitcoin operates.

Friedberg goes into how a hard fork is different from what most would normally consider a fork within an open source software context:

“A ‘hard fork’ by nature is not backward compatible and requires network participants to adopt new software changes. Failure of all applicable network participants to take such action will result in the Bitcoin network validating different sets of consensus rules. This will result in bitcoin users following different ledgers (called blockchains). There will be a variance in the decentralized truths about bitcoin transactions, as the replacement software will result in a new replacement virtual currency. ‘Hard forks’ are not to be confused with software forks in Open Source, which is a copy of an existing project.”

While Friedberg is an admitted user and holder of the original form of Bitcoin, his blog post gives compelling reasoning why the hard fork, although possibly well-intentioned, might wind up being disastrous not only for the new currency creators and users, but also for those involved with the original Bitcoin platform.

New Hard Fork Founders May Be Held Liable

Unlike Satoshi Nakamoto, who was and still is anonymous, the founders of the divergent currencies Bitcoin Classic and Bitcoin XT are not. They would need to register with the Financial Crimes Enforcement Network (FinCEN) once they are being transacted like a new convertible virtual currency. They would be required by both Federal and some state laws within the USA to take a myriad of precautions against money laundering, terrorist funding, fraud prevention and loss. Most importantly they’d be liable for damages potentially and also be liable for punishment. Specifically, whomever is listed on the websites as having direct or collective control over the direction of the forked currencies could face harsh legal consequences if they do not in a timely manner report their forked currency as a Money Service Business (MSB) to the FinCEN.

Failure to register can result in imprisonment of not more than 5 years, as well as civil penalties. 31 U.S.C. § 5330(e) and 31 C.F.R. § 103.41(e); 18 U.S.C § 1960(b)(1)(B). This is in addition to potential state penalties, as certain states also regulate virtual currency creators.

AML Protocols Will Identify Users

Due to Anti Money-Laundering rules, Bitcoin Classic and Bitcoin XT would likely need to be able to identify their users. With original Bitcoin, the system is decentralized and trustless and does not require personal identifying information of its users. If the hard-forked currencies are to develop within compliance, they will need to depart from this dearly held aspect of the original Bitcoin community, which could hurt its viability for adoption within the larger cryptocurrency community.

Bitcoin’s creator designed bitcoin to allow peer-to-peer financial exchange without the use of financial intermediaries and all the complexities involved with such intermediaries, such as identifying the users.

Exchanges and Wallets Operations Will Be More Complicated

Wallets will be challenged to deal with these hard forks of Bitcoin and won’t be able to mix, match or intermingle them at all. The actual market value and liquidity of the different currencies would be very different from one another, so any mixing would cause a severe imbalance of the real value associated with the hard forks versions and the original. The results of this complication could make some wallets unable to effectively operate their businesses.

Potential Liability for Miners Who Do Or Do Not Adopt New Protocol

If miners accept the new protocol unilaterally and convert original Bitcoin to any of the hard forks, they could be liable for damages to those who receive the new currencies, either knowingly or unknowingly. Due to the un-unanimous nature of deciding how the hard fork is processed, users of Bitcoin won’t have a say in securing the value of their Bitcoin if some miners work with the new protocol and others don’t.

There are also numerous state statutes prohibiting computer crimes which could be applied to miners who unilaterally convert bitcoin into a new type of virtual currency. Bitcoin users have a business expectation that their Bitcoin transactions will be processed by miners using the established Bitcoin protocol, and miners should be cautious about interfering with this expectation.

A Troubled Road Ahead For Bitcoin Classic and Bitcoin XT

One thing that is clear from Friedberg’s arguments is that there are many catch-22s in the arguments for and against the hard fork. With improved transaction times and increased block size, the new currencies in Bitcoin Classic and BitcoinXT are exposing themselves to liability. Furthermore, what these new currencies will have to do to comply with regulations might make their core principles so different from the original Bitcoin that they may become alienated from the original community.

Friedberg’s law firm specializes in the representation of Fintech businesses, virtual currency creators, digital wallets, blockchain companies, miners and exchangers in addition to peer-to-peer lenders, crowd-funders, payment companies, and data security companies.

Featured image from Shutterstock.

Last modified: June 27, 2020 10:39 AM UTC

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