MOWAT RESEARCH #168 | AUGUST 2018

Inside the
Black Blocks
A policymaker’s introduction to
blockchain, distributed ledger
technology and the “Internet of Value”
BY MICHAEL CRAWFORD URBAN
WITH DANIELLE PINEDA

MUNK SCHOOL OF
GLOBAL AFFAIRS &
PUBLIC POLICY
Acknowledgements
The authors would like to thank those who participated in this research project as key informant
interviewees and anonymous reviewers. A special thanks to Andrew Parkin, Sunil Johal, Kiran
Alwani, Catherine Stinson and Reuven Shlozberg for reviewing the paper and for their helpful
feedback, as well as Elaine Stam for going above and beyond in her design work for this report.
Any remaining errors are the sole responsibility of the authors.

Authors
MICHAEL CRAWFORD URBAN DANIELLE PINEDA
Practice Lead, Policy Intern
Government Transformation Danielle worked at the Mowat Centre as a
Michael joined the Mowat Centre as a Policy Intern from May to August 2017. She
Policy Associate in January 2016 and took has also worked for Ontario’s Ministry of
on the role of Practice Lead, Government Health and Long-Term Care, the Legislative
Transformation in September 2017. He Assembly of Ontario and provided teaching
brings a varied set of experiences to his and research support at the University of
work at Mowat having worked at Global Toronto. She is currently a Policy Analyst at
Affairs Canada in Ottawa – most recently AdvantAge Ontario. Danielle holds a Master
as a Cadieux-Léger Fellow – with Elections of Public Policy and Honours Bachelor of Arts
Canada and in the think-tank and NGO degree in Political Science and Media Studies
sectors in Toronto and Ottawa. He holds from the University of Toronto.
degrees from Queen’s University, Carleton
University and the University of Oxford.

Disclosure: Michael Crawford Urban owns a

small amount of bitcoin and ether.

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Contents
Executive Summary 1

1 Introduction
A gap in the literature
5
6

2 What is a blockchain anyway?

Blockchain basics
Critical features
8
8
10
What problem is blockchain solving? 11
The “double-spend” problem 13
How blockchain works 14
What the fork? 19
Why mine? 21

3 The first digitally native value system

Digital commerce
New forms of economic activity
24
24
30
The dimensions of the blockchain revolution 34

4 Potential uses by the broader public sector

Electronic health records
Professional and post-secondary credentials
42
42
43
Government permits, licensing and “verifiable claims” 44

5 Implications for public policy

Competition in “governance services”
Decreasing effectiveness of “negative” regulatory frameworks
49
49
54
Novel legal questions 55
Governance 57

6 Recommendations
Build internal capacity
Create an attractive environment for blockchain innovation
61
61
64
Support allied and internal experimentation 67
Make greater use of standards and other flexible tools 68
Foster national and global governance cooperation 69

7 Conclusion
Key takeaways
Blinded by the hype?
73
73
74
 Is blockchain
the most
important
innovation
since the
Internet, or an
over-inflated
hype-bubble
that will soon
burst?
INSIDE THE BLACK BLOCKS
EXECUTIVE SUMMARY
Is blockchain the most important innovation since the Internet, or an over-inflated hype-bubble that
will soon burst? Either way, and even if the truth lies somewhere between these two extremes, rapidly
growing interest in blockchain and its potential applications means that policymakers need to quickly
develop an understanding of this new technology to guide their engagement with it.

Fortunately, there is no shortage of information about blockchain available to policymakers wishing to

learn more about it. Unfortunately, too many of the rapidly growing number of articles, YouTube videos,
reports and Twitter threads on the subject are of limited use, for one of two reasons.

On the one hand, many of these pieces are too superficial, speculative or insufficiently rigorous to be
of much use to policymakers. On the other, pieces that do engage at a deeper level often end up losing
the forest for the trees by focusing too narrowly on blockchain’s technical aspects. These accounts
intimidate and confuse readers without technical backgrounds while the mass of detail they provide
obscures many of the most important aspects of this innovation.

Compounding this problem is the fact that few of either type of report are targeted specifically at
policymakers.

This report fills this gap by providing an accessible yet rigorous explanation of how blockchain works
and a non-technical but still detailed analysis of the concepts and phenomena that underpin this
explanation. It does so with an eye to the significance of blockchain and its potential applications for
public policy as well as the potential that exists for governments to use blockchain to advance their
own objectives. Throughout, the report also describes potential applications of blockchain and profiles
a collaborative blockchain proof of concept conducted by the Government of Canada, the Government
of Ontario and the City of Toronto.

We begin with a discussion of what a blockchain actually is and highlight the six essential components
of a true blockchain:
1 | THE MOWAT CENTRE

»» The ability of multiple collaborators to make additions to the blockchain.

»» A “write-only” design that ensures information can only be added to the blockchain and never deleted.

»» Hosting of the blockchain on a decentralized peer-to-peer (P2P) network.

 »» The use of a distributed consensus mechanism how blockchain, by empowering individuals and
by the network for automatically reaching networks, may undermine the usefulness of
decisions on whether to accept or reject many of the negative regulatory frameworks –
proposed additions to the blockchain. frameworks designed to block certain activities –
that governments have previously used to achieve
»» An incentive structure integrated into the
many of their policy objectives. The third issue to
blockchain’s software that ensures that the
watch concerns the fact that blockchain’s spread
nodes maintaining it work together.
will likely create a host of novel legal questions
»» The use of cryptography to ensure the security, – such as how to regulate “smart contracting.”
integrity and reliability of the information Finally, we examine the question of how the
recorded in the blockchain and of the systems governance of blockchain technology and
which manage it. blockchains themselves will need to evolve.
We then provide an accessible and non-technical
After identifying these issues, the report offers
explanation of how a blockchain actually
a set of preliminary recommendations for
works. Often glossed over in other reports, we
policymakers as they respond to blockchain’s
explain the process in simple terms because
arrival. These include a recommendation to build
understanding these foundational details is
internal capacity so that governments can stay
critical to understanding the larger debates
abreast of blockchain’s evolution and not be
about blockchain’s potential and being able to
entirely reliant on outside consultants. We also
cut through the ubiquitous hype that so often
discuss how to build an attractive environment
surrounds it.
for blockchain innovation in Canada. These
Building on this explanation, we also identify first two recommendations both depend on,
and explore the fundamental implications of and could help government support, internal
blockchain’s emergence. To do this, we analyze and allied experimentation with potential
the two channels through which blockchain blockchain applications so as to ensure that
is likely to have its most important impacts: the public sector can access its potential
by enabling greater automation and greater benefits. Insofar as applications of blockchain,
decentralization in both the economy and society. such as cryptocurrencies, require regulation we
Building on these ideas, we explore a number of recommend that government take a collaborative
potential use cases in the broader public sector, approach that makes greater use of standards
such as electronic health records, professional and other flexible regulatory tools. Finally, we
and post-secondary credentials, as well as strongly recommend that the Government of
government permit issuing and licensing. Canada actively lead the fostering of national and
global governance cooperation on blockchain.
We use this analysis to then identify four critical
2 | INSIDE THE BLACK BLOCKS

“Issues to Watch.” The first of these, competition

in governance services, focuses on how
blockchain enables a much wider range of actors
to participate in the market for services, such
as the provision of currencies, previously tightly
controlled by governments. Second, we discuss
Informed by this analysis, the report closes by
identifying three key takeaways for policymakers:

»» Blockchain marks the arrival of the first

“digitally native value system.” This in turn lays
the foundation for potentially revolutionary
forms of automation by enabling software to do
many new and important things that it cannot
easily do today.

»» Blockchain and associated technologies offer

other less revolutionary, but still significant,
innovations in terms of organizing and
coordinating information systems and tracking
a variety of assets. These implementations will
enable greater efficiency and decentralization
which could help secure greater privacy and a
more even distribution of economic and social
power.

»» The most significant implications of blockchain

will arise from its interactions with other
emerging technologies such as artificial
intelligence and the Internet of Things. Thus,
it is critical for government to understand and
engage with all of these innovations as part
of a wider and interconnected technological
revolution which will require a holistic public
policy response.

Naturally, there are many other issues related

to blockchain that will grow in importance in
the future but which are not covered here. We
hope that, given this report’s analysis of the
fundamental concepts and questions raised
by this new technology, readers will be better
prepared to engage with these issues, ask the
right questions and separate what is real from
what is hype.
3 | THE MOWAT CENTRE
 To avoid being
caught flat-footed,
policymakers will
need to understand
the basic outlines
of blockchain, what
it enables us to
do that we could
not do before and
what this means for
governments and how
4 | INSIDE THE BLACK BLOCKS

they operate.
1 INTRODUCTION
On 31 October, 2008, a mysterious individual, or group of individuals, known only as Satoshi Nakamoto,
posted a link to a paper entitled Bitcoin: A Peer-to-Peer Electronic Cash System to an obscure mailing list
called Cryptography List.2 In this paper, Nakamoto proposed the creation of what would become known
as a blockchain as a means of enabling an electronic payment system that did not require a trusted
third party intermediary.

While Nakamoto has never been publicly1 Still, despite the huge investment in this nascent
identified, less than a decade later, Nakamoto’s sector, the incredible growth in the markets for
idea has spawned a new class of digital assets digital assets and the massive potential for
whose value, as of January 2018, was estimated disruption in a host of industries, blockchain
at more than $800 billion (USD). Even with2
is still absent from many policymakers’ radar
a subsequent market correction, the market screens – let alone those of most average
capitalization of all existing cryptographic assets citizens. Even for those who have taken notice,
is, at the time of this writing, somewhere around few understand the technology much beyond
$300 billion. More than that, transformative
3
having a vague impression that it has something
applications for the new technology beyond to do with Bitcoin.4
digital cash are being suggested in areas as
diverse as securing digital property, administering This needs to change because, even if blockchain
smart electrical grids, enabling self-driving and fails to fulfill its proponents’ wildest claims,
self-owning charitable taxis and giving patients or the value of a bitcoin5 drops to nothing,
vastly greater control over their own health the opportunities and challenges posed by
records. blockchain will offer some of the most significant
technology-driven tests faced by governments in

4 Research conducted on behalf of the Bank of Canada in late

2017 found that 64 per cent of Canadians have heard of Bitcoin but
only 2.9 per cent of Canadians actually own any bitcoin. See Henry,
5 | THE MOWAT CENTRE

1 The paper has been preserved at https://bitcoin.org/bitcoin.pdf. C. Huynh, K. and Nicholls, G. December 2017. “Bitcoin Awareness
2 Kharpal , A. 6 February, 2018. “Over $550 billion wiped off and Usage in Canada.” Staff Working Paper 2017-56 (English). The
cryptocurrencies since record high just under a month ago.” CNBC. Bank of Canada. https://www.bankofcanada.ca/2017/12/staff-
https://www.cnbc.com/2018/02/06/bitcoin-price-over-550-billion- working-paper-2017-56/.
wiped-off-cryptocurrencies-since-record-high.html. 5 In this paper we follow a common convention when referring to
3 This estimate was made on 25 July, 2018. See https:// bitcoin. When we use the capitalized Bitcoin, we are referring to the
ca.investing.com/crypto/currencies for an up to date estimate. Bitcoin network, blockchain or software protocol. When we use the
These are necessarily very rough estimates. lower-case bitcoin, we are referring to the currency.
 the next quarter century. Moreover, because of confuse readers without technical backgrounds
how they will likely interact with and enable many and the mass of technical detail they provide
of the most highly touted technological advances obscures many of the most transformational
currently under development, such as artificial aspects of blockchain that are of the greatest
intelligence (AI) and the Internet of Things significance for policymakers. Compounding this
(IoT), blockchain and related distributed ledger problem is the fact that few of either type of these
technology (DLT) will likely represent some of the reports are targeted specifically at policymakers.7
foundational technologies of the 21st century
economy. To avoid being caught flat-footed, The critical middle ground that is missing
policymakers will need to understand the basic from both these categories is an accessible
outlines of blockchain, what it enables us to do yet rigorous explanation of how blockchain
that we could not do before and what this means will actually create the changes that are being
for governments and how they operate. described and a detailed but non-technical
analysis of the concepts and phenomena that

A gap in the literature underpin this explanation. This is unfortunate

because without such accounts policymakers
There is no shortage of information about will not be able to develop the understanding of
blockchain. In fact, the Internet is overflowing blockchain required to appreciate its potential
with explainer articles, videos and reports implications. Without such an understanding,
specifically aimed at explaining what blockchain policymakers will not be able to seize the
is and how it works.6 Unfortunately, too many opportunities presented by blockchain while also
of these pieces fall into one of two categories. avoiding its challenges.8
On the one hand, many are too superficial
The present report aims to fill this gap by
and insufficiently rigorous to be of much
providing the sort of accessible yet rigorous
practical use. While they may provide a brief
explanation just described. The next section
impressionistic sketch of how a blockchain works
explains blockchain in a straightforward way that
and perhaps catalogue a few industries that
will provide the reader with the basic technical
many are predicting will be disrupted by it, they
understanding needed to engage the larger
lack the deeper analysis that policymakers will
policy questions discussed later on in the report.
need to grapple successfully with the challenges
The third section builds on this explanation by
and opportunities that blockchain will create.
exploring the fundamental implications of this
Alternatively, many accounts that do seek to technical innovation. This third section is aimed
engage at a deeper level end up losing the forest squarely at filling the aforementioned gap in the
for the trees by narrowly focusing on blockchain’s existing policy research literature by providing
technical aspects. These accounts intimidate and
6 | INSIDE THE BLACK BLOCKS

7 A notable recent exception: Berryhill, J., Bourgery, T and Hanson,

A. 2018. “Blockchains Unchained: Blockchain Technology and
its Use in the Public Sector.” OECD Working Papers on Public
6 Some better examples of these include: MIT Technology Review Governance. No. 28. http://dx.doi.org/10.1787/3c32c429-en.
Editors. April 23, 2018. “What is a blockchain?” MIT Technology 8 It is true that there are some useful book length documents
Review. https://www.technologyreview.com/s/610833/explainer- of this type that exist. See Vigna, P. and Casey, M. 2016. The Age
what-is-a-blockchain/. Centre for International Governance of Cryptocurrency: How Bitcoin and the Blockchain are Challenging
Innovation. 4 January, 2018. What is Blockchain? Centre for the Global Economic Order. New York: Picador. and Casey, M. and
International Governance Innovation (CIGI). https://www.cigionline. Vigna, P. 2018. The Truth Machine: The Blockchain and the Future of
org/multimedia/what-blockchain. Everything. New York: St Martin’s Press.
readers with an examination of blockchain’s This report draws on a research project focused
foundational concepts and implications. If you on blockchain technology that was initiated
already know what a blockchain is and how it by the Mowat Centre in January 2017. It has
works, consider skipping directly to this section. involved interviews with almost 20 public
servants, academics, entrepreneurs, practitioners
Building on these ideas, the fourth section and thought leaders working in the blockchain
explores a number of potential use cases in the sector or in related areas as well as extensive
broader public sector, such as electronic health reviews of academic and grey literatures, informal
records and professional and post-secondary consultations and jurisdictional scans.
credentials. The fifth section then turns to an
examination of four “Issues to Watch” which will Finally, as one of our interviewees pointed out,
pose critical questions for policy- and decision- one of the reasons that there is such a poor
makers. The report closes with a series of five general understanding of blockchain is that it is
high-level recommendations for governments as not “the easiest thing to understand.” Blockchain,
they consider how to respond to the emergence represents a counter-intuitive and potentially
of blockchain and DLT. We also offer some brief radical new way of doing certain things that have
concluding thoughts. been done the same way for centuries or, in some
cases, a way of doing things that have never been
Importantly, this report is not designed to be done before. If anyone is presenting blockchain
comprehensive in its discussion of blockchain as simple or easy to understand, it’s likely you will
or its applications. At this point, it is much more come away from this interaction missing some
important for policy- and decision-makers – as critical pieces of the puzzle.
well as the interested public – to develop an
understanding of the foundational concepts and In the pages that follow we tackle this complexity
issues that it raises. Thus, our aim is to provide head on, break it down and provide the reader
policymakers with the basic intellectual tools with the clear exploration of blockchain
they will need to continue their exploration of this technology that has been lacking in a public
new technology with confidence. Ultimately, our policy context. Ultimately, when someone starts
success will be measured by the extent to which talking about “X” amazing thing that blockchain
readers come away with confidence in their ability will do, we want the reader to be able to ask
to ask the right questions about blockchain as it the questions they will need to ask to be able
grows in importance. to cut through the hype and determine whether
and how “X” might actually impact the work of
government.
7 | THE MOWAT CENTRE
 2 WHAT IS A
BLOCKCHAIN ANYWAY?
Ironically, for something so intimately associated with the technology sector and Silicon Valley-style
innovation, the creation of blockchain did not involve the invention of anything new. In fact, all the
components of blockchain existed for years prior to its invention. What is innovative about blockchain,
however, is its unique combination of these pre-existing elements into a novel configuration that
produced something that was much more than the sum of its parts.

In this section, we provide a thorough account Blockchains get their name from the process by
of what that “something” is and what it can which new transactions are added to this ledger.
do. For simplicity’s sake, the focus in this When a user wishes to enter a new transaction
section is on the Bitcoin blockchain because, into the ledger, they must first propose, or “post,”
as the first blockchain ever created, it set the this transaction to the network. Once it has been
basic pattern for subsequent iterations. Once posted, the transaction is grouped together with
a basic understanding of what a blockchain a number of other transactions posted at around
is has been established, we will expand our the same time. This group of transactions is then
focus in subsequent sections to exploring other verified to ensure their validity and, if they are
blockchains, how they differ from Bitcoin, and confirmed as valid, they are time-stamped and
how they have helped further develop this new “sealed” into a new “block.” Through the use of
technology. a technique called “hashing,” this new block is
cryptographically connected to a “chain” of other
Blockchain basics blocks which were created earlier and which
stretch all the way back to the first or “genesis”
A blockchain is, fundamentally, a digital ledger block which initiated the blockchain. This process
that lists the ownership of a set of assets, as well of connecting new blocks to the chain of older
as an essentially tamper-proof transaction history ones ensures that once a block has been added
for those assets. Blockchains are operated by a to the chain, earlier blocks cannot be tampered
8 | INSIDE THE BLACK BLOCKS

peer-to-peer (P2P) network of computers in which with as doing so would break the connection with
each of the computers that form a node on the and invalidate newer blocks (see Figure 1).
network independently maintains a complete
copy of the ledger. Each copy is regularly updated
as the nodes of the network work together to
record every transaction that occurs on the
blockchain in a way that ensures all copies
remain consistent with each other.
FIGURE 1
How a blockchain works

1 2
Someone proposes adding a new The proposed transaction is
transaction to the blockchain. broadcast to a P2P network of
computers, called nodes, that
operate the blockchain.

3 4
The network gathers a set volume of proposed
The new block is then broadcast to the
transactions together. Using the network’s established
entire network.
consensus mechanism, one node verifies and seals
these proposed transactions into a new block.

5 6
Each node independently verifies the validity of the The proposed update is now a part
9 | THE MOWAT CENTRE

transactions in the new block. If they are deemed of the blockchain.

acceptable, each node adds this new block to their
copy of the blockchain.

9 Source: PwC. September 2015. Money is no object: Understanding the evolving cryptocurrency market. PwC. https://www.pwc.com/us/en/
industries/financial-services/library/cryptocurrency-evolution.html.
 An important feature of the Bitcoin blockchain While DLT is discussed in this report, the core
is that it is public and “permissionless,” meaning focus is on blockchain. This is because, while
that it can be viewed in its entirety by anyone and DLT has significant potential of its own, it is
that anyone can transact on it or set themselves neither as novel, nor potentially as revolutionary,
up as one of the nodes that helps to maintain it. an innovation. Given that the focus of this report
One important implication of this is that, because is on understanding blockchain and its potential
every transaction is recorded on the blockchain, implications, broadening the focus too much risks
it is possible to trace the entire transaction further muddying already cloudy waters.12
history of each and every bitcoin ever created.
For a variety of reasons that we will explore So, what is so innovative about blockchain?
throughout this report, some innovators have Fundamentally, blockchain enables, for the
also sought to create “private” or “permissioned” first time, reliable, transparent, searchable
blockchains where the abilities to view the and auditable version control of a shared and
blockchain, propose transactions and act as a immutable distributed ledger in real time,
node maintaining it are restricted in various ways. without the need for a trusted central authority
or intermediary to maintain that ledger. While

Critical features there is no universally accepted definition

of blockchain,13 we find it useful to define a
Based solely on this overview, it can be difficult to blockchain as combining the following six
recognize what is so special about a blockchain. features:
Further complicating matters is the fact that there
»» The ability of multiple collaborators to write to
has been a purposeful blurring of the already
the ledger without a single central point/entity
loose definition of a blockchain by a variety of
empowered to accept or decline these proposed
actors seeking to associate their own offerings
additions.
with the much-hyped technology as a means
of attracting financing and attention.10 Many of »» A “write-only” design that allows information
these technologies are similar to blockchain, or to be added to the ledger but not deleted. While
incorporate some of its component technologies, the current state of the ledger can continue to
but differ in crucial respects. Indeed, given the be changed, these changes represent updates
extent to which the term blockchain is contested, of the existing record, the entirety of which
some have abandoned the term altogether and remains accessible on the ledger.
refer instead to “distributed ledger technology” or
DLT, a broader term that captures blockchains as
well as other related technologies.11 12 This is not to say that DLT is not important as in many cases it
will actually be a distributed ledger that gets implemented and not
a blockchain, properly defined. Nevertheless, this paper focuses
10 | INSIDE THE BLACK BLOCKS

10 For an extreme example, see Shapira, A. and Leinz, K. 21 on blockchain as a way of exploring the potential of this new
December, 2017. “Long Island Iced Tea Soars After Changing Its technology with as few qualifications, and with the most clarity,
Name to Long Blockchain.” Bloomberg. https://www.bloomberg. possible – even if actual implementation of the technology, in the
com/news/articles/2017-12-21/crypto-craze-sees-long-island-iced- form of less revolutionary distributed ledgers, will sometimes fall
tea-rename-as-long-blockchain. short of this full potential.
11 UK Government Chief Scientific Adviser. December, 2016. 13 We have arrived at this list of features through our own
Distributed Ledger Technology: beyond block chain. Government independent research and believe that this represents a robust
of the United Kingdom. https://assets.publishing.service.gov. working definition that side-steps many of the unhelpful technical
uk/government/uploads/system/uploads/attachment_data/ debates that currently exist and incisively captures the critical
file/492972/gs-16-1-distributed-ledger-technology.pdf. features of a true blockchain.
»» The hosting of the ledger on a distributed P2P
network where each full node in this network What problem is
possesses a regularly updated copy of the blockchain solving?
entire ledger.
To understand the capabilities enabled by
»» A distributed consensus mechanism by which
blockchain, and why they add up to something
the network automatically reaches decisions on
innovative, it helps to understand the problem
whether to accept or reject proposed additions
that blockchain was created to solve. On the
to the ledger.
surface, this problem may not seem like such a
»» Some form of incentive structure to ensure big deal but, as is explained below, the creation
that the nodes maintaining the blockchain of blockchain technology actually resolved a
provide the computing power needed to do long-standing problem in computer science in a
so. For public blockchains like Bitcoin, this revolutionary way.
usually takes the form of a “coin” or “token” that
Stated simply, blockchain solves a coordination
nodes can receive as a reward, while private or
problem for shared ledgers. Commonly, shared
“permissioned” blockchains employ a greater
ledgers with multiple collaborators are vulnerable
variety of incentives structures.14
to confusion or tampering leading to errors
»» The use of cryptography to ensure the security, infiltrating the ledger because it is hard to
integrity and immutability of the information coordinate the actions of multiple users when
recorded in the ledger and the systems by which they are acting independently. For example,
it is managed. one collaborator could accidentally record a
transaction that another had already recorded
without realizing it. Alternatively, one collaborator
might make a transcription error and since no one
else was checking their work, the error would go
unnoticed, thus corrupting the ledger.

In some cases, these are problems people are

willing to live with. Google Docs is an example of
an application where multiple collaborators can
make changes to a single file and where errors
or disagreements can creep in. Correspondingly,
users will often develop systems for how to alter
such files that reduce the likelihood that problems
like this will arise, for example, by requiring
users to “track changes” and use “commenting”
11 | THE MOWAT CENTRE

functions to propose, discuss and agree on

changes before they are implemented in the file.
Such systems can work well when a group is
14 Some purists would argue that permissioned blockchains are relatively small and known to each other – i.e., a
not really blockchains at all precisely because they believe that an
incentive structure that employs tokens is an essential component trusting community – but they can also be labour
of a blockchain. In this report, we do not take this position.
 intensive and time-consuming to implement confirm whether the transaction is valid – by
and coordinate properly. Moreover, because directly contacting the cardholder for instance.
they depend on voluntary human actions and If the transaction is deemed fraudulent, the card
are not written into the application’s software, company will use its authority over the ledger
such systems are subject to human error and to reverse the transaction and reimburse the
can quickly break down when numbers grow and cardholder.
when anonymous users and users not known to
one another begin to participate. While there are benefits to such a system –
refunds for defrauded cardholders for instance
In trusting communities, efforts to solve – there are a number of drawbacks that such
coordination problems are aimed at keeping intermediated systems create, including:
errors out of the ledger. In “trustless”
communities – the aforementioned communities Gouging
of anonymous users or users not known to The granting of special rights and privileges to a
each other – the number of potential problems central authority creates an opportunity for that
expands. Users, who must still guard against authority to overcharge users. Many believe that
honest errors, must now also guard against credit card companies and banks do just that
malicious users who are purposefully seeking and point to the fact that they are able to extract
to add incorrect information to the ledger and fees from both the cardholder and the merchant
potentially seeking to defraud others. It is in involved in a transaction and are able to make
these trustless communities that coordination sizeable profits from this business. It is because
difficulties can mutate from a simple nuisance of how these fees eat into their profits that many
into a serious security problem and can even small business owners prefer cash or debit
block collaboration. payments and why some even decline to accept
credit cards at all.
A common solution to the problems posed by
coordination in trustless communities is to Corruption
create a “trusted” intermediary and give them
Systems that centralize authority enable
special powers to oversee the ledger.15 Credit card
corrupt individuals and organizations to take
companies represent an example: you agree to
advantage of the privileges that their authority
a transaction with a merchant and enter it into a
provides them. Land registries in countries
terminal that transmits the proposed transaction
without a strong rule of law often confront this
to the card company. The company reviews the
problem as individuals may need to pay bribes to
transaction to see if it appears fraudulent and to
administrators in order to get their transactions
determine if the cardholder possesses sufficient
processed, and administrators may steal
credit. If all is well, the transaction is accepted,
12 | INSIDE THE BLACK BLOCKS

individuals’ title to their land by destroying or

a new credit is added to the merchant’s account,
secretly altering the records that they maintain.
and a new debit to the cardholder’s account.
If fraud is suspected, the card company will
utilize the special information it possesses to

15 For the sake of efficiency and convenience, this solution is

sometimes attempted in trusting communities as well.
 One obvious solution to all these problems is
Single points of failure
to decentralize the system, that is, create a
Centralization also generates a more fundamental system where there is no central authority and
structural problem, namely the creation of what multiple redundant copies of the information in
are called “single points of failure.” These arise question are stored in different places by different
when a vital system is operated by, or critical independent entities. If there is no central
information is stored by, a single entity or in a authority, it cannot become abusive; if there are
single place. The 1 June, 2018 crash of the Visa multiple copies of the ledger, then taking one of
network in Europe provides a recent example them offline cannot stop users from accessing
of just such a failure.16 Similarly, while users of another copy.19 But, while an obvious and simple
Google Docs may be able to log on and edit their solution in principle, prior to the invention of
shared files from anywhere in the world, a single blockchain, implementing such a decentralized
updated version of the document is maintained solution for a shared ledger was impossible in the
by Google. The result of this centralization of context of a trustless world.
storage is that if Google’s servers are taken offline
by a cyber-attack or natural disaster, this can shut
Google Docs down thereby temporarily blocking
The “double-spend”
everyone’s access to their shared document.17 problem
Honeypots The biggest reason why no one had been able to
solve this problem previously was because no
Centralization, specifically of storage of users’ one had been able to solve the “double-spend”
data – something often associated with systems problem.20 To understand the double-spend
that centralize authority – also creates what are problem, consider the problem in the context
called “honeypots.” The term honeypots refers of a digital currency and imagine a digital unit
to large accumulations of data held in a single of money which we will call a “token.” Because
location or database. These centralized stores of computers are very good at copying things – and
data are especially attractive to hackers because also very good at making millions of these copies
of their immense size and potential value. This at low cost – it is not possible to create value-
makes it worthwhile for the hackers to devote bearing digital files that act the way a physical
significant effort and resources to breaching coin or a dollar bill acts in the physical world.
these stores’ defences. Thus, this concentration Counterfeiting is simply too big a problem. One
of data often ends up resulting in massive data way to get around this problem, however, is to
breaches, even from highly protected databases, a avoid bearers of value altogether and opt instead
problem that is becoming increasingly common.18 for a centralized ledger that keeps track of what
everyone owns and owes. When someone wants

16 Collinson, P. and agency. 2 June, 2018. “Visa card payments 19 Note that decentralized systems also tend to limit the amount
13 | THE MOWAT CENTRE

system returns to full capacity after crash.” The Guardian. https:// of data in the copies of the shared ledgers to the absolute minimum
www.theguardian.com/money/2018/jun/01/visa-card-network- necessary for the system to function. This makes them much less
crashes-and-sparks-payment-chaos?CMP=Share_iOSApp_Other. attractive targets for hackers.
17 It is true that companies like Google try to alleviate this 20 The double spend problem is most easily understandable in
problem by backing up files, but in principle, because these files are the context of a digital currency, but the same problem can be
controlled by a single entity, they are still vulnerable to the single transposed to other forms of ledgers as well. In order to make the
point of failure problem – for example, should Google go bankrupt. explanation as clear as possible, we concentrate on the currency-
18 A recent example is the September 2017 Equifax data breach. related form of this problem here.
 to make a purchase, they don’t exchange tokens. In other words, any decentralized system needs
Instead, they simply notify the keeper of the to find a way to ensure that all the various copies
ledger to shift some tokens from their account of the ledger remain consistent and are regularly
to someone else’s. In this scenario, a token reconciled in a way that reliably ensures that
becomes less analogous to a physical thing like a legitimate transactions can be distinguished
coin and more like a unit for measuring how much from illegitimate ones and only legitimate ones
of something you possess, like a kilogram or a accepted. Prior to the creation of the Bitcoin
millilitre. blockchain, no one had been able to solve this
problem; blockchain’s key innovation lies in how it
As already discussed, this solution works well manages to do so.
if there is a trusted intermediary to maintain
the ledger and keep track of transactions. For
a variety of reasons, the inventor(s) of Bitcoin
How blockchain works
and its early adopters were unhappy with the Blockchain’s key innovation lies in how it creates
fact that such a payment system required them a system for coordinating the maintenance
to rely on an intermediary. Thus, the Bitcoin
21
of a shared ledger by a decentralized network
blockchain represents an attempt to create a such that all the copies of the ledger across
functional equivalent of the sorts of ledgers the network can be reliably updated in a
that card companies use to enable electronic timely manner and in a way that ensures their
payments, but to do so without a centralized consistency.
authority. Instead, a decentralized network would
operate the ledger, thereby ensuring that no single How does blockchain accomplish this previously
entity would be able to exploit a privileged central impossible task?22 We explained earlier that
position. blockchains are updated when a new block
of transaction information is time-stamped,
The problem that this creates, however, is that sealed and added to the chain of blocks that
removing the intermediary re-introduces the comprise the ledger. A block is simply a package
double-spend problem, albeit in a different of information of a pre-determined size. In
form. Without a central authority empowered principle, this information can record any sort
to coordinate the updating of the authoritative of transaction, ranging from the transfer of
central ledger, this network needs a new way to ownership of a digital asset like a bitcoin to
ensure that malicious users are not able to spend the transfer of ownership of a physical asset
the same funds more than once by entering like a diamond that has been registered on a
different transactions for their funds into the
multiple copies of the ledger distributed around
the network.
14 | INSIDE THE BLACK BLOCKS

21 Bitcoin’s creator(s) seem to have wanted to be able to transfer

funds digitally with the same level of anonymity and ease that cash 22 For this section, and many of the other technical aspects of
enabled in the physical world and they resented the power that this paper, we have relied on the helpful and accessible explanation
the managers of existing ledgers, such as banks, enjoyed because offered at Nielsen, M. 6 December, 2013. “How the Bitcoin
of their privileged position – a position that also enabled them protocol actually works.” DDI: Data-driven Intelligence. http://www.
to profit from their management of the ledger. See Vigna, P. and michaelnielsen.org/ddi/how-the-bitcoin-protocol-actually-works/ as
Casey, M. 2016. The Age of Cryptocurrency. Chapter 2. well as the helpful comments of our anonymous reviewers.
blockchain.23 The way this works is that when The prize for winning the competition is actually
users want to make an addition to the ledger the nonce itself which the winning node is then
– i.e., make a transaction – they announce it able to use as a special cryptographic key that
to the blockchain’s network. These proposals enables them to seal the next block of validated
are validated and grouped together into a block updates and attach it to the rest of the blockchain
and the blockchain’s distributed consensus (see Box 1). The various nodes on the network
mechanism is then used to add this block to the compete to perform this task because the node
ledger. that wins the competition is rewarded with a
set number of new bitcoins for doing so. Taking
In the case of the Bitcoin blockchain, the part in this competition – i.e., engaging in this
consensus mechanism that is used is based on computational work – is called “mining” and the
a technique called “proof-of-work” (PoW).24 PoW nodes that do it are called “miners.”26
is essentially a competition held between the
various nodes that make up the Bitcoin network
in which each node strives to be the first to
guess a random number –called the nonce – that
happens to solve a difficult mathematical puzzle.
There is no way to find the nonce other than by
guessing a number and running an equation to
see if that number produces the correct answer.
This “guess and check” approach, also called
brute force computation, is similar to trying to
open a combination lock by trying every possible
combination one at a time.25 And just like with a
combination, it is easy to prove to someone else
that you have succeeded in solving the problem
by simply telling them the combination and
having them test it themselves – which is how
other nodes can check to ensure that the winner
of the competition actually found the nonce.

23 Volpicelli, G. 8 June, 2016. “Beyond bitcoin. Your life is destined

for the blockchain.” Wired. http://www.wired.co.uk/article/future-
of-the-blockchain. The big difference between transferring digital
and physical assets, however, is that while recording the transfer
15 | THE MOWAT CENTRE

of bitcoin on the Bitcoin blockchain actually effects and completes

the transfer, when recording the transfer of a physical asset that 26 Note that all of this activity occurs automatically. Human
transfer must still be effected in the physical realm. involvement in the mining process is normally limited to setting
24 PoW serves two necessary functions in the Bitcoin blockchain: up a mining “rig” – the computer or network of computers used
on top of being a consensus mechanism, it also ensures the to do the mining – and periodically checking on it to make sure
security of the system, as we explain below. it is still working properly. That said, the potential deviations
25 The authors would like to thank Matt Jackson for suggesting described below would involve human interference with a normally
this comparison. automated process.
 BOX 1
Hashing
Hashing is a term that refers to the use of an algorithm – called a hash function – to convert a
piece of information into an alphanumeric string of characters like this:

e9ffc424b79f4f6ab42d11c81156d3a17228d6b1edf4139be78e948a9332d7d8

Hashing is a commonly used technique in computer science and cryptography. Hashes are useful
because they possess a few important properties. First, hashes are extremely sensitive to any
change in the information from which they were generated. For instance, if the hash above was
the result of the text of a book being hashed, the simple act of removing even a single period from
that text and then hashing the text again would result in the generation of an entirely new and
unpredictably different string of characters.

Second, some hash functions – such as SHA-256, the hash function used by Bitcoin but also many
other common digital applications – are very useful for cryptographic purposes. While it is easy
to apply the function to a piece of information and generate a hash, it is essentially impossible
to do the inverse and figure out what the underlying information is simply by inspecting the hash
itself. Thus, if you have access to the underlying information used to generate a hash, it is easy to
determine if the person who generated it does as well, while if you only have the hash itself, you
will be unable to determine what that underlying information actually is.

In the Bitcoin blockchain, hashing plays a critical role. The number guessing competition that
constitutes mining is actually a competition to guess a number (called the nonce) that, when
added to the transactions in the proposed block and hashed using the SHA-256 hash function,
will generate a hash starting with a specific number of zeros. The specific number of zeros
required is automatically set by the Bitcoin software and varies depending on the “hashrate” of
the Bitcoin network. The “hashrate” of the network is a measure of how much computing power
is being devoted to maintaining the network at that particular point in time. The Bitcoin software
automatically varies the difficulty of the competition depending on the network’s hashrate so as to
maintain an average interval between block creation of about 10 minutes.27

Once the nonce has been guessed correctly, it is then hashed again alongside the transaction
information for the block being sealed and the hash of the preceding block (see Figure 2). It is
in this way, namely hashing all the information in a block and then using this hash as a part of
the information that produces the next block, that Bitcoin makes itself essentially tamper-proof.
Any attempt to go back in time by tampering the record of historical transactions will alter the
16 | INSIDE THE BLACK BLOCKS

underlying information of the hash of the block in which this transaction was recorded, thereby
invalidating the hashes of subsequent blocks and breaking the chain.28

27 In reality, the average time per block has been slightly below 10 minutes for most of Bitcoin’s history. See https://data.bitcoinity.org/
bitcoin/block_time/all?f=m10&t=l.
28 For a more detailed explanation of hashing see 3Blue1Brown. 7 July, 2017. “Ever wonder how Bitcoin (and other cryptocurrencies)
actually work?” YouTube. https://www.youtube.com/watch?v=bBC-nXj3Ng4 and Nielsen, M. 6 December, 2013. “How the Bitcoin protocol
actually works.”
FIGURE 2
Blockchain detail

K
OC
S BL
IOU
EV
F PR
O
SH Alice pays John
HA 6 Bitcoins
Mark pays Sara
8 Bitcoins
Mike pays Alfred
5 Bitcoins
CE
ON
HEN
T
HA
SH
FU
NC
TIO
N

HA
SH
FU
NC
TIO
N

17 | THE MOWAT CENTRE

 This mathematical puzzle is important because it allow a user to transfer the same asset to more
serves three key functions: than one other user simultaneously (an obvious
»» It makes participation in the competition costly form of double-spending). Nor would it validate
by requiring participating nodes to dedicate proposed transactions that are inconsistent with
significant computing power to maintaining the the pre-existing state of the database – e.g., a
network. user attempting to transfer an asset that they do
not own.
»» It yields an answer that is easy to confirm after
the fact but essentially impossible to uncover Once they have sealed the block, the winning
without winning the competition. miner broadcasts this new block to the rest of
»» Because the nonce can only be found by the network and each of the other miners update
guessing random numbers, it is basically their copies of the blockchain by adding this new
impossible to predict who will win any given block. Before doing so, however, each miner will
round of the competition, thereby randomizing independently verify that the solution that the
which miner gets to seal each block. competition winner found to the mathematical
puzzle is correct and that the additions to
While dedicating additional computing power to the blockchain proposed in the new block are
finding the nonce will improve a miner’s chances compatible with their copies of the blockchain.
of winning, doing so does not guarantee victory This step is important because technically the
– especially because all the other competitors winner of the competition could try to introduce
are trying to do so as well. In other words, the improper transactions that benefited them into
competition is like a lottery and while adding the blockchain when they seal the block and
computational power will improve a miner’s odds broadcast it to the rest of the network. But any
of winning because it will allow them to guess such attempt would immediately be noticed by
and check more numbers more quickly – similar the other nodes when they received the proposed
to buying additional tickets – the winner of the new block with the result that this new block
competition will still be determined by random would be promptly rejected by the network and
chance. the process would be re-run. Because it is so
easily caught, attempts like this are not a regular
Once a miner finds the nonce and seals the block,
occurrence.
the next step is to broadcast this new block to
the rest of the network. It should be noted that
prior to sealing the block, prior even to searching
for the nonce, the miner will have automatically
validated all the pending transactions that it
had gathered to put into this new block. The
18 | INSIDE THE BLACK BLOCKS

process of validation is fairly straightforward

and consists of the copy of the Bitcoin software
that operates the miner’s node checking to see if
there are any inconsistencies within the proposed
transactions that make up the proposed block.
For example, the Bitcoin software does not
What the fork? FIGURE 3

One of the interesting things about Bitcoin is Normal blockchain growth

that, while a new block is created every ten
minutes, most users of Bitcoin do not consider
a transaction to have been completed until an Miners
additional five blocks have been added to the
New block
blockchain. In order to understand why this is the
case, we need to explain one additional feature of Miners
blockchains, namely something called “forking.” New block

Because blockchains are maintained by a

decentralized worldwide network of computers, BRANCH A
it is possible for more than one node on the
FIGURE 4
network to independently solve the mathematical Miners
Forked blockchain
puzzle and win the competition to seal the next BRANCH A

block at basically the same time. When this

Miners
occurs, more than one node will broadcast a new
Miners
block to the network essentially simultaneously.
While communication between nodes takes BRANCH B

place very quickly, it is not instantaneous

Miners Branch A Miner
because geographical location, routing of the move to Branch
BRANCH B
information on the Internet, and the quality
BRANCH A
of the transmission infrastructure will impact Branch A Miners
transmission speed. Thus, the spreading of new move to Branch B
Normally, however, this competition between Mi
blocks across the network will proceed unevenly branches does not last long because the Bitcoin
BRANCH A
and at different rates. This uneven spreading can software contains another rule designed to
Min
result in a situation where multiple nodes on the resolve it: the longest branch of the blockchain
network may accept one new block while other is considered the official branch and miners
BRANCH B
nodes, having received an alternate new block should only work on extending the official branch.
from a different node first, will have accepted a Thus, as soon as one of the competing branches
different block and added it to their blockchains. BRANCH B
successfully adds another block to the chain, this
now longer branch becomes the official branch.
The Bitcoin software manages this “forking” of
Once nodes that were working on the other, now
the blockchain – the name given to situations
shorter, branch are informed that there is now
when the blockchain has been split into multiple
a longer branch, they will automatically stop
branches as just described – by using the
working on extending the shorter branch and
19 | THE MOWAT CENTRE

following rule: all nodes simultaneously keep

transfer their attention to the now official branch
track of both branches of the chain but only work
(see Figure 5). The blocks in the shorter chains
on extending the branch containing the new block
that have been abandoned are called “orphan
that they accepted first. The result is that there
blocks.”
are temporarily two competing versions of the
blockchain (see Figure 4).
 BRANCH A

Miners

FIGURE 5 would go back in time on the blockchain and

Miners propose a new block that contained a new
Forked blockchain being resolved
BRANCH B
transaction history for the bitcoins in question
Branch A Miners
move to Branch B
in which they never transferred these bitcoins to
their counterparty. The idea being that if they can
BRANCH A
get the rest of the network to accept this new
Miners
transaction history they can recover the funds
they spent while still enjoying the benefits of the
transaction.
BRANCH B

FIGURE 6
While not unusual or problematic, forking does
enable the double-spend problem to re-emerge Attempt to fork a blockchain retroactively
in a new form. In this context, double-spending
BRANCH A
refers to a scenario in which a fraudster
The Fraudster
Miners
completes a transaction with another user and
then, at some point later in time after they have
secured the benefit of this first transaction – say BRANCH B

taken possession of the pizza they purchased

through that transaction – seek to remove the
record of this transaction from the blockchain. The only way that such a manoeuvre would be
In other words, by erasing the record of their successful is if the fraudster were somehow able
transaction, they are seeking to destroy the to convince the rest of the network that their new
evidence that it occurred and return the official and fraudulent branch of the blockchain should
blockchain to the state that existed before be accepted as the official branch. Otherwise the
they transferred the bitcoins used to make the fraudster would simply be operating their own
purchase out of their account, thereby allowing private branch of the blockchain with no one else
them to spend these same bitcoins again in the paying any attention to them or engaging in any
future. The result would, in some ways, be similar transactions with them. Essentially, it would be
to passing a bad cheque. a bit like trying to spend your own homemade
currency at the grocery store.
The way that a fraudster would try to do this is
by waiting until they have secured the benefit
of the transaction and then return to a point
on the blockchain, usually the block just prior
to the one in which the transaction in question
20 | INSIDE THE BLACK BLOCKS

was recorded, and then fork the blockchain by

proposing a new block in which that transaction
no longer exists.29 In other words, the fraudster

29 Note, in this scenario all the other transactions in the block

would remain the same – only the transaction of interest to the
fraudster would be altered.
To be successful, the fraudster would need to transaction has been completed: the assumption
extend their new fraudulent branch of the chain is that once that many blocks have been added,
such that it overtakes the legitimate chain – the it is so improbable that the transaction could
one that includes the original transaction – in be overtaken by a fraudulent branch of the
length. While theoretically possible, the Bitcoin blockchain that they can now rest assured that it
blockchain is specifically designed to make such has been permanently added to the blockchain.
a scenario essentially impossible. The main
defence that is built into the Bitcoin blockchain FIGURE 7
is PoW. While it is possible for anyone to fork the
Bitcoin blockchain at any time, once they have Blockchain with forks and orphan blocks
created the first block in the new branch, they ORPHAN
BLOCK

will have to seal each subsequent block in this

ORPHAN
BLOCK OFFICIAL
new chain themselves. This is because, until BRANCH

they overtake the official branch the rest of the

network will still be focused on extending the
longer official chain. ORPHAN
BLOCK

Given that the difficulty of finding the nonce

will be the same for the fraudulent actor and
the rest of the network against which they are
still competing, it is tremendously unlikely that
Why mine?
the fraudster will be able to seal enough blocks A final key point to note about blockchain design
fast enough to overtake the original branch and is the role played by the distributed P2P character
displace it as the official branch. While they
30
of the network. The consensus mechanism relies
could reasonably expect to get lucky and seal a on the fact that each node has access to its own
block or two faster than the rest of the network, copy of the blockchain to ensure that whoever
being able to do so for an extended period of wins the competition is able to independently
time becomes so unlikely as to be essentially validate the new block of transactions. This
impossible. That is why users of the network makes it is essentially impossible to corrupt
usually wait until five additional blocks have been the ledger by hacking it. In the first instance
added to the chain before assuming that their this is because, given that each block in the
chain contains a hash of the preceding one, it is
30 The integrity of this system would be threatened, however, essentially impossible to alter the record as doing
if a single entity came to control a sufficiently large percentage
of the computing power dedicated to the network that they
so would break the modified block’s connection
could, essentially, guarantee their ability to win the lottery. This with subsequent blocks and create a fork in the
hypothetical problem is referred to as a “51 per cent attack,” though
there are some who argue that one could probably mount such chain (see Box 1). Additionally, the fact that each
an attack with less than 51 per cent of the network’s computing node has its own copy of the ledger means that
21 | THE MOWAT CENTRE

power. At the moment, the Bitcoin blockchain does not appear

to be vulnerable in this way. For a more in-depth discussion, see it would be simply too difficult to simultaneously
Hertig, A. 8 June, 2018. “Blockchain’s Once-Feared 51% Attack Is hack enough nodes for the hacker to be able to
Now Becoming Regular.” Coindesk. https://www.coindesk.com/
blockchains-feared-51-attack-now-becoming-regular/. and Eyal, I alter sufficient copies of the ledger to overwhelm
and Gün Sirer, E. No date. Majority is not Enough: Bitcoin Mining is the non-corrupted versions of the blockchain.
Vulnerable. Cornell University. https://www.cs.cornell.edu/~ie53/
publications/btcProcFC.pdf.
 The major drawback to this otherwise ingenious for these updates in many blocks. Thus, users
scheme for preventing corruption of the ledger will now often offer modest fees alongside their
is that the entire system relies heavily on proposed transactions in order to induce miners
redundancy and is thus quite inefficient. The to include their proposed transaction in a block
difficulty of winning the competition to seal the in a timely manner. Thus, between mining new
next block is automatically tied to the amount bitcoins and receiving transaction fees, Bitcoin
of computing power that nodes have dedicated miners are provided with an incentive to maintain
to maintaining the network. While it was initially the decentralized system.
possible to successfully mine bitcoins using
only a standard laptop computer, the amount
of computing power competing to seal the next
block, and the costs involved in purchasing the
electricity to enter this competition, are now
so high that attempting to mine bitcoins using
anything other than specially designed hardware
is a money losing proposition.31

But, if participating in this competition is

expensive, why does anyone compete? The
answer is twofold. First, blockchains usually
include a system that incentivizes participation
by providing the winner of the competition with
a reward, usually in the form of a token. In the
Bitcoin blockchain, this reward is a set number of
bitcoins.32 Second, when users notify the network
of their proposed update and request that it be
included in the next block, they can also offer
a fee for processing their update. During the
first few years of its operation, these fees were
minimal or non-existent on the Bitcoin blockchain.
But as the volume of updates has grown there are
now often more proposed updates than space

31 Eventually this energy intensity may force the adoption

of alternative consensus mechanisms by Bitcoin and other
blockchains. Ou, E. 7 December, 2017. “No, Bitcoin Won’t Boil
22 | INSIDE THE BLACK BLOCKS

the Oceans.” Bloomberg. https://www.bloomberg.com/view/

articles/2017-12-07/bitcoin-is-greener-than-its-critics-think.
32 Initially, the reward for successfully sealing a block was 50
bitcoins. Interestingly, the Bitcoin software is set such that the
reward decreases by half about every four years. Currently, the
reward sits at 12.5 bitcoins (worth, at the time of this writing, over
$130,000 CAD). Eventually, the reward will decrease to nothing with
the 21 millionth, and final, new bitcoin likely appearing sometime
around 2140, depending on what the average time required per
block actually ends up being.
 At some point
you need
someone to
staple this
physical thing
and this digital
thing together...
and the stapler
can always
corrupt the
system.
23 | THE MOWAT CENTRE
 3 THE FIRST DIGITALLY
NATIVE VALUE SYSTEM
With this understanding of how blockchain functions in place, we can shift our focus to the potential
implications of this new technology. As was mentioned earlier, applications for blockchain technology
are being proposed, developed and launched across an increasingly diverse array of sectors ranging
from personal digital identity management, to electricity grids,33 to digital pet breeding games.34

In subsequent sections we highlight a few of these applications. Before diving too deeply into specific
applications, however, it is important to first get to grips with the fundamental innovations introduced
by blockchain which underpin these new applications. Thus, in this section, we focus on the two key
dimensions along which blockchain’s impact will likely flow, namely automation and decentralization.

Digital commerce
Before examining these two key dimensions, however, it is useful to quickly review the context into
which blockchain is emerging and illuminate the significant changes to this context it may trigger.

Enthusiasts often suggest that blockchain is important because it creates an “Internet of Value” in the
same way that the worldwide web created an “Internet of Information.”35 Similarly, others suggest that
blockchain is the “distributed trust network that the Internet has always needed but never had.”36 Care
should be taken with these catchy turns-of-phrase, however, as it is often unclear what they actually
mean or what the implications of an “Internet of Value” might be. After all, we can already transfer value
across the Internet fairly easily – as shown in Figure 8, digital commerce is already booming.
24 | INSIDE THE BLACK BLOCKS

33 Briggs, L. 2 December, 2016. “NEWS: Energy May be Ripe for the Sharing Economy, Thanks to Bitcoin’s Blockchain Technology.” Advanced
Energy Perspectives. http://blog.aee.net/news-energy-may-be-ripe-for-the-sharing-economy-thanks-to-bitcoins-blockchain-technology.
34 See https://www.cryptokitties.co/.
35 Hasse, F. von Perfall, A. Hillebrand, T. Smole, E. Lay, L. Charlet, M. 2016. Blockchain – an opportunity for energy producers and consumers?
PwC. https://www.pwc.com/gx/en/industries/energy-utilities-resources/publications/opportunity-for-energy-producers.html. Page 40.
36 Marc Andreessen, quoted in Tapscott, D. and Tapscott, A. 2016. Blockchain Revolution: How the Technology Behind Bitcoin is Changing
Money, Business and the World. London: Portfolio Penguin. Page 5. This is a confusing quotation as the great innovation of blockchain is not
that it creates a network of trust, but rather, that it eliminates the need for trust.
FIGURE 8 BOX 2
Growth of digital commerce Fiat Currency
4.5
Trillions (USD)

3.9 The term “fiat currency”

refers to the money, such
3.3
as Canadian dollars, that
2.8
we currently use and
2.3 which have value only
1.9
because some entity,
1.3 1.5
such as a government
2014 2015 2016 2017 2018 2019 2020 2021 or central bank, has
PROJECTED SALES
declared them to have
this value. This value is
Source: Orendorf, A. 1 September, 2017. Global Ecommerce: Statistics and International usually substantiated by
Growth Trends [Infographic]. ShopifyPlus. https://www.shopify.com/enterprise/global-
ecommerce-statistics and Statisa. 2018. “Retail e-commerce sales worldwide from an individual’s ability to
2014 to 2021 (in billion U.S. dollars).” E-Commerce. Statisa. https://www.statista.com/ pay the taxes owed by
statistics/379046/worldwide-retail-e-commerce-sales/.
them to said government
in currency backed
What is special about blockchain is how it has enabled, for the by this government.
first time, the creation of what we call the first “digitally native Fiat money has no
value system.” More than anything else, it is this innovation that independent intrinsic
stands to enable blockchain’s most revolutionary consequences. value, as opposed
to representative
The key difference between existing forms of value that can be currency (where money
transferred digitally and blockchain-enabled forms of digital represents a claim on
value is that unlike existing forms – such as “fiat” currencies a commodity, usually
(see Box 2) like dollars, euros, yen – which are only represented held by a government)
digitally, blockchain allows the creation of forms of value that are or commodity money
intrinsically digital. Most existing systems of value are created (where the money has
and controlled through legislation. These currencies derive intrinsic value by dint
their value from a system of laws that exists independent of the of the usefulness of
digital realm. This means that any digital representation of these
the commodity, often a
precious metal, out of
forms of value is only the representation of an original version
which it is made).
which is ultimately controlled and defined by that other system.
Alternatively, blockchain-enabled assets are originally digital
and are controlled and defined by software. Their existence is a
function of the digital system they are embedded in, impossible
25 | THE MOWAT CENTRE

outside of this context and independent of any national system

of laws.37

37 For an in-depth discussion of the legal character of Bitcoin and the difficulties
involved in understanding it using traditional legal concepts, see Szilagyi, K. 2018. “A
Bundle of Blockchains? Digitally Disrupting Property Law.” Cumberland Law Review. 48(1)
9-34.
 This is new and profoundly important. Digitally
native value systems represent a potentially
tremendous disruption to the institutions that
currently manage the connection between
existing digital representations of existing forms
of value and their physical and legal anchors.
These intermediary institutions, which derive
considerable power from their roles as such,
are currently necessary because, as one of our
key informants put it, “at some point you need
someone to staple this physical thing and this
digital thing together... [and] [t]he stapler can
always corrupt the system.”38 When a form of
value is inherently digital, however, this is no
longer true because the stapler is no longer
necessary. Consequently, those currently holding
the stapler stand to lose a great deal of their
power.

While much has been made of the disruptive

potential that blockchains possess vis-à-vis
traditional financial institutions, this potential
disruption is just one of many possible
repercussions of the even more fundamental shift
that the advent of digitally native value systems
entails. Indeed, the most significant result that
is likely to emerge from blockchain’s creation
of digitally native value systems lies in how the
novel characteristics of these systems will enable
new areas of economic activity that were not
previously possible.

38 Corruption is perhaps a strong word, but the point is clear.

26 | INSIDE THE BLACK BLOCKS

Banks and governments exercise tremendous power over the

existing financial system, but this power is often hidden. Only
rarely, for instance when the Greek government and the country’s
banks effectively froze Greeks’ bank accounts in 2015 and limited
them to a maximum of only €60 worth of withdrawals a day, does
this power become obvious. The Associated Press. 29 June, 2015.
“Greece in limbo as it shuts banks, puts limits on cash withdrawals
to avoid financial collapse.” The National Post. http://business.
financialpost.com/news/economy/greece-in-shock-as-banks-shut-
after-creditor-talks-break-down.
 BOX 3
Digital Assets
According to Investing.com there are now more than 1,900 “cryptocurrencies.”39 While many of these,
such as Bitcoin, are best understood as something akin to a traditional currency, for many of these
assets the term “cryptocurrency” is actually misleading as it implies a level of homogeneity among
these assets that does not exist. Increasingly, the terms “crypto assets” or “digital assets” are being
used as a way of referring to this universe of distinct digital tokens.40

In an attempt to organize this expanding universe, Don and Alex Tapscott have developed an initial
typology that divides this new class of assets into seven categories.41 Drawing on their work,
we define each of these categories below and provide examples of particular tokens for each
category. It is important to note, however, that this list is offered as a helpful guide and is by no
means definitive or exhaustive. The divisions between these categories are blurry as many are
still emerging and evolving, and any attempt at such categorization will need to be amended in the
months and years to come.

CRYPTOCURRENCY
A blockchain-based system of digital cash money that serves as a P2P medium of exchange, store
of value and unit of account and which uses cryptographic techniques to generate new units of
money and to secure the system against corruption. Cryptocurrency has no physical form and
exists only on the network. Units of different cryptocurrencies can be exchanged for each other or
exchanged for fiat currency. This money-changing usually occurs at cryptocurrency “exchanges,”
institutions that act like digital foreign currency exchanges. Bitcoin is the most well-known
cryptocurrency, but other cryptocurrencies that focus on providing specific functionalities such as
Zcash (improved privacy) or Litecoin (faster transaction confirmations) also exist.

PLATFORM TOKENS
Similarly to cryptocurrencies, platform tokens are units of value within digitally native value
systems. Unlike cryptocurrencies, which are specifically designed to enable secure digital payment
systems, platform tokens are designed to serve as value systems for general purpose blockchain-
based software platforms capable of supporting additional functions beyond payments. Ether, the
token that is native to the Ethereum platform, is the most well-known of these tokens. Ethereum, a
blockchain that emerged out of its creators’ frustration with the Bitcoin blockchain’s limited ability
to support applications other than digital payments, was designed to provide users with the ability
to run “smart contracts” (business logic and agreements encoded in software - see Box 4) – and
DApps (decentralized applications, i.e., software programs like Bitcoin that run on a decentralized
P2P network) on its network. The role of the ether token, which represents an entitlement to the
27 | THE MOWAT CENTRE

use of some of the Ethereum network’s decentralized computing power – often called “gas” – is a
component of an internal pricing system used to allocate the computing power of the network.

39 See https://ca.investing.com/crypto/currencies This estimate was made on 26 July, 2018.

40 Garner, B. 14 February, 2018. “What is Storj? | Beginner’s Guide.” CoinCentral. https://coincentral.com/storj-beginners-guide/.
41 Tapscott, A. 28 March, 2018. “Crypto Summit 2018 | Alex Tapscott: Global State of Crypto.” YouTube. https://www.youtube.com/
watch?time_continue=1602&v=YM4EwxQ3eFY.
 UTILITY TOKENS
Like cryptocurrencies and platform tokens, utility tokens are also units within digitally native value
systems. Contrary to platform tokens, which are native to general purpose decentralized computing
systems, utility tokens serve as units of value within the digital value systems created by specific
DApps. Thus, while a DApp might require a platform token such as ether to pay nodes on the
Ethereum network for the computational work they perform to run the DApp, users of the DApp
would need to spend or hold that DApp’s native utility token to participate in the activities of that
DApp. Storj, a decentralized cloud storage DApp that runs on the Ethereum network, is one such
example. Storj users who want to store data (called tenants) upload data to the cloud through the
Storj DApp. Storj processes this data and deposits it with users who have spare storage capacity
(called farmers). Tenants whose data is being stored pay the farmers who are storing their data
using Storj’s native utility token.ᵝ

SECURITY TOKENS
Security tokens are best understood as securities – such as stocks or other equities – issued
digitally on a blockchain platform. In other words, security tokens are tokens that constitute an
“investment contract” and thus meet the legal criteria used to define a security. These criteria are
often referred to in the USA as the “Howey Test” or, in Canada, by the name of the court case (Pacific
Coast Coin Exchange v. Ontario Securities Commission) that imported a slightly wider version of the
Howey Test into Canadian law. Essentially, according to this test, a token is a security if it involves:
»» an investment of money
»» in a common enterprise
»» with the expectation of profit
»» to come significantly from the efforts of others42
There are many potential advantages to issuing securities on a blockchain, such as faster clearing
and settling of transactions, better tracking of ownership, and other features enabled by the fact that
these tokens, unlike paper share certificates, are programmable, meaning they can be controlled by
software.43ᵝ

NATURAL ASSET TOKENS

While similar to security tokens in that they represent an entitlement to the ownership of an
asset, natural asset tokens represent ownership of a physical asset, such as a specific amount of
gold or oil, instead of an intangible asset like a share in a company. Alex Tapscott suggests that
these tokens might be most useful in creating or advancing what he calls “frontier markets” in
physical assets like atmospheric carbon emissions. Indeed, some interviewees told us that some
28 | INSIDE THE BLACK BLOCKS

governments are already examining the possibility of using blockchains to implement carbon pricing
systems.

42 Canadian Securities Administrators. 24 August, 2017. “Cryptocurrency Offerings.” CSA Staff Notice 46-307. http://www.osc.gov.on.ca/en/
SecuritiesLaw_csa_20170824_cryptocurrency-offerings.htm.
43 Currently, however, many existing securities tokens have likely been issued without meeting many of the requirements, such as the issuing
of a regulator-approved prospectus, that have been set by securities regulators. Consequently, many of these token are likely illegal offerings.
DIGITAL COLLECTIBLES
In much the same way that the creation of blockchain technology solved the double-spend problem
for digital currency, its creation of “digital scarcity” is now enabling the production of unique non-
replicable digital collectibles. The most well-known of these are CryptoKitties which exist as tokens
in a blockchain-based game in which players are able to collect and breed unique digital “cats.”
Other collectibles have started to emerge, such as the ability to buy a share of a musician’s song44
or digital trading cards. Indeed, impressed by the success of CryptoKitties, Major League Baseball
announced that it will soon launch a blockchain-based game involving crypto-collectible avatars
from significant moments in baseball history which users will be able to collect and trade with
each other.45 The market for digital collectibles may be larger than one would initially imagine: in
computer gaming circles, the sale of fraudulent digital items such as in-game weaponry – which
for our purposes count as collectibles – is a major problem in a growing market already worth 15
billion USD.46

CRYPTO-FIAT CURRENCIES OR STABLECOINS

Given how the current volatility of cryptocurrencies has undermined their usefulness as a medium
of exchange, some have suggested that governments could issue a digital fiat currency on a
blockchain as a means of overcoming this problem. The idea would be that such a currency
would marry many of the advantages of a fiat currency, such as the stability that can derive from
government backing, with many of the advantages of a cryptocurrency, such as faster transaction
speeds and the ability to easily transfer money across borders. Stablecoins, such as Tether, seek
to achieve much the same result by creating a system whereby the value of a token is pegged to a
specific physical asset like gold or oil or even to an existing fiat currency.47

44 Krewen, N. 10 December, 2017. “Want to buy a piece of a Drake song? Track’s rights sold via pioneering digital currency scheme.” The
Toronto Star. https://www.thestar.com/entertainment/music/2017/12/10/want-to-buy-a-piece-of-a-drake-song-tracks-rights-sold-via-
pioneering-digital-currency-scheme.html.
45 Kelly, M. 13 July, 2018. “MLB will release a crypto baseball game on the blockchain.” The Verge. https://www.theverge.
com/2018/7/13/17568766/mlb-cryptocurrency-baseball-game-summer.
46 Casey, M and Vigna, P. 2018. The Truth Machine. Page 96. An important innovation that sets blockchain-based collectibles apart from
other digital ones is that they exist on a decentralized network and are thus less vulnerable to the single point of failure problem that
exists for other digital items, such as collectibles in online games run by a single company like World of Warcraft. Wong, J. 4 December,
29 | THE MOWAT CENTRE

2017. “The ethereum network is getting jammed up because people are rushing to buy cartoon cats on its blockchain.” Quartz. https://
qz.com/1145833/cryptokitties-is-causing-ethereum-network-congestion/.
47 Venezuela’s petro, a digital currency that it began issuing in February 2018 and which it claims is backed by Venezuela’s oil reserves,
appears to represent some combination of these two ideas, but it may also be a scam designed to circumvent international financial
sanctions. Laya, P. “Crypto Rating Sites Are Already Calling Venezuela’s Petro a Scam.” Bloomberg. https://www.bloomberg.com/news/.
articles/2018-04-03/crypto-rating-sites-are-already-calling-venezuela-s-petro-a-scam and Karsten, J. and West, D. 9 March, 2018.
“Venezuela’s “petro” undermines other cryptocurrencies – and international sanctions.” TechTank. The Brookings Institute. https://www.
brookings.edu/blog/techtank/2018/03/09/venezuelas-petro-undermines-other-cryptocurrencies-and-international-sanctions/.
 New forms of economic FIGURE 9
activity Space of possible economic
relationships, circa 2007
Some commentators compare the invention
of blockchain to the invention of double-entry
bookkeeping. Often, this comparison is designed
to highlight the foundational importance of Mortgage

blockchain but also to caution readers not to Credit card

balance
Loan from
expect too much from blockchain too soon. After parents

all, while double-entry bookkeeping may have

Stock
enabled the development of modern capitalism, ownership Interest-bearing
bank deposit
it took hundreds of years before the practice
became a ubiquitous backbone technology of
commerce.48 The space illustrated in Figure 9 represents all
economic relationships between individuals
Another analogy that may be better at illustrating that could theoretically exist. The portion of the
how blockchain can enable novel forms of space in the bottom right-hand corner – coloured
economic activity is to consider how other light green and encompassing the five icons
Loan from
new developments, such as the invention of – represents all the economic relationships
parents
joint stock companies, did so when they were that were actually available at the level of
launched. The creation of these technologies technology that existed prior to the invention of
Interest-bearing
enabled a new class of enterprises to raise capital bank deposit
blockchain technology. The five icons represent
in innovative ways and to create business models illustrative examples of the many potential
and businesses that were not previously viable. relationships available within that portion of
These new economic entities also opened up the space. Because of how technology changes
previously restricted commercial opportunities over time, the size of this space of possible
to a wider percentage of the population than economic relations also changes as the level
Mortgage

ever before and helped to spur significant wealth of technological development changes. For
Loan from
creation and economic growth. example, Figure 10 represents the space parents
of
possible economic relationships as well as the
Josh Stark, a lawyer and blockchain entrepreneur, Stock
ownership
actual relationships available to the ancient
Interest-bearing
illustrates this idea by using a concept that bank deposit
Romans. Notice how it is smaller and more limited
he calls the “space of possible economic
in examples than Figure 9.
relationships.”49 We have adapted his graphical
representation of this concept in Figures 9 -12.
30 | INSIDE THE BLACK BLOCKS

Mortgage

48 The Economist. 15 July, 2017. “Disrupting the trust business.” Cryptocurrencies Credit card
balance
The Economist. https://www.economist.com/news/world- Loan from
if/21724906-trust-business-little-noticed-huge-startups-deploying- parents
blockchain-technology-threaten.
49 Stark, J. 26 July, 2018. The Space of Possible Economic Initial coin Stock
Relationships. Medium. https://medium.com/@jjmstark/the-space- offerings ownership Interest-bearing
of-possible-economic-relationships-bca4511fa88b. bank deposit
 Mortgage Mortgage

Credit card
balance
Loan from Loan from
parents parents

Stock Stock
FIGURE 10 ownership Interest-bearing FIGURE 12 ownership Interest-bearing
bank deposit bank deposit
Space of possible economic Space of possible economic
relationships in ancient Rome, circa 200 relationships, circa 2018

Mortgage
Mortgage
Cryptocurrencies Credit card
Credit card balance
Loan from Loan from
balance
parents
Loan from parents
parents

Initial coin Stock

Stock Interest-bearing offerings ownership Interest-bearing
ownership bank deposit
Interest-bearing bank deposit
bank deposit

Over time, technology developed and new ICOs provide good examples of how the sort of
innovations arrived making more of this space expansion described in these figures is occurring
available. In Figure 11, we illustrate how the as well as its potential impacts, both good and
space had evolved and expanded by the mid-
Mortgage bad. ICO proponents argue that they offer an
1800s. easier way for investors to raise funds than
Loan from
parents
Loan from through existing sources like angel investors and
parents
venture capitalists. They also argue that ICOs are
FIGURE 11 Stock
ownership Interest-bearing more democratic and fair because of how they
Space of possible economic bank deposit
Interest-bearing
bank deposit provide retail investors anywhere in the world
relationships in Victorian England, circa with the opportunity to invest in exciting new
1850 technologies at the ground level, an opportunity
previously reserved for well-connected and
already wealthy accredited investors.
Mortgage
Mortgage
Cryptocurrencies Credit card
balance
Loan from
parents
Loan from
parents

Initial coin Stock

offerings ownership
Stock Interest-bearing
ownership bank deposit
Interest-bearing
bank deposit

As is shown in Figure 12, the advent of

blockchain is further increasing the proportion
of the space of possible economic relationships
31 | THE MOWAT CENTRE

Mortgage
that is available as new inventions such as
Cryptocurrencies Credit card
cryptocurrencies and initial
balance coin offerings (ICOs)
Loan from
parents
emerge.
Initial coin Stock
offerings ownership Interest-bearing
bank deposit
 ICOs have proven both popular and lucrative
BOX 4
as it is estimated that in 2017, entrepreneurs
Initial Coin raised more funds through ICOs than from

Offerings (ICOs) traditional early-stage venture capital.50 This is

not necessarily a positive development, however,
as ICOs have their shortcomings. Many ICO
An ICO is an unregulated sale of
projects may never deliver any real results, and a
digital coins or tokens generally
few will be outright scams or frauds.51 Moreover,
used by blockchain start-ups
given the terms of some ICOs, these tokens may
and entrepreneurs to raise funds
for their ventures. Sometimes in fact constitute securities in a legal sense,
these coins have characteristics, meaning that, in order to be legal offerings, they
such as voting rights or the must comply with the same disclosure and other
right to use a service offered regulatory requirements as traditional securities.
on that blockchain, associated Many ICOs are likely illegal given their failure to
with them. The purchase of do so.52 But just as it was not worth abandoning
the tokens sold in an ICO is joint stock companies as a financial tool because
usually made using one of the of early failures like the catastrophic Darien
most popular cryptocurrencies Scheme53 or frauds like ones that helped produce
such as bitcoin or ether. The the South Seas bubble,54 the fact that an ICO can
term ICO is modelled after be misused or can fund a project that ends up
the term IPO, or Initial Public
being bungled does not mean that the instrument
Offering, which refers to the
is itself necessarily flawed or irredeemably
raising of investment capital
compromised.
by a private corporation
through the regulated sale of
stock to the public for the first
time. ICOs are controversial
because of their unregulated
nature and are banned in some
countries such as China. In
other countries, regulators have 50 The Economist. 9 November, 2017. “The meaning in the
warned consumers that many madness of initial coin offerings.” The Economist. https://www.
economist.com/news/leaders/21731161-there-ico-bubble-it-holds-
of the tokens sold in ICOs may out-promise-something-important-meaning.
constitute illegal securities. 51 Higgins, S. 15 February, 2018. “CFTC Joins SEC In Warning
Against Crypto Pump-and-Dumps.” Coindesk. https://www.coindesk.
Other jurisdictions, such as com/cftc-joins-sec-warning-crypto-pump-dumps/.
Singapore, Hong Kong and 52 Rawle, G. and Rizvi, Z. 7 September, 2017. “Cooling the
Blockchain Boom: CSA Staff Narrow the Path for Cryptocurrency
Switzerland are more accepting
32 | INSIDE THE BLACK BLOCKS

Offerings.” Bulletin. Davies Ward Phillips & Vineberg LLP. https://

and accommodating of ICOs. www.dwpv.com/en/Insights#/article/Publications/2017/CSA-Staff-
Narrow-Path-for-Cryptocurrency-Offerings.
53 Carroll, R. 11 September, 2007. “The sorry story of how
Scotland lost its 17th century empire.” The Guardian. https://www.
theguardian.com/uk/2007/sep/11/britishidentity.past.
54 President and Fellows of Harvard College. No date. “South
Sea Bubble Short History.” South Sea Bubble Resources in the Kress
Collection at Baker Library. Harvard Business School. https://www.
library.hbs.edu/hc/ssb/history.html.
ICOs are still a very new means of raising capital and
thus it is not yet possible to know exactly which of
their features will become significant. One example of
how this innovation can create new types of economic
relationships lies in the ability of platform and utility
tokens to create new incentive structures for token
holders – as opposed to the incentive structures that
exist for holders of traditional securities. Indeed, contrary
to a cryptocurrency, proponents argue that many tokens
are better understood as similar to a license or a coupon
that confers the holder with the right to use a company’s
service or platform in the future.55 Because of how
these utility tokens essentially represent IOUs for future
services, they provide a built-in incentive to participate
in the activities and communities that these tokens are
associated with.56

By this logic, ICOs would be similar to “local currencies”

– such as Ithaca HOURS – in that they fix value within
a particular economic network in a way that helps build
community, albeit in a non-geographical digital context.57
Some have argued these characteristics could help to
reduce the sorts of short-term profit seeking that are
exhibited by many of those who own traditional securities
– a short-term focus that arguably encourages sub-
optimal corporate decision-making.58

55 Adlerstein, D. and Tinianow, A. 21 April, 2018. “Why ICOs Could Eat

Delaware’s Lunch.” Coindesk. https://www.coindesk.com/icos-eat-delawares-
lunch/.
56 Korjus, K. 19 December, 2017. “We’re planning to launch estcoin — and
that’s only the start.” Republic of Estonia E-Residency Blog. Medium. https://
medium.com/e-residency-blog/were-planning-to-launch-estcoin-and-that-
s-only-the-start-310aba7f3790; Johnson, S. 16 January, 2018. “Beyond
the Bitcoin Bubble.” The New York Times Magazine. https://www.nytimes.
com/2018/01/16/magazine/beyond-the-bitcoin-bubble.html.
57 Jacob, J. Brinkerhoff, M. Jovic, E. Wheatley, G. 23 May, 2004. “The Social
and Cultural Capital of Community Currency, An Ithaca HOURS Case Study
Survey.” International Journal of Community Currency Research. 8. pp.42-56.
https://ijccr.files.wordpress.com/2012/05/ijccr-vol-8-2004-4-jacob-et-al-2.
pdf. See also Gilbert, K. 22 September, 2014. “Why Local Currencies Could Be
On The Rise In The U.S. -- And Why It Matters.” Forbes. https://www.forbes.
33 | THE MOWAT CENTRE

com/sites/katiegilbert/2014/09/22/why-local-currencies-could-be-on-the-
rise-in-the-u-s-and-why-it-matters/2/#8279c837259a and De, N. 5 June, 2018.
“Lawmaker Wants New York State to Pilot Local Cryptocurrencies.” Coindesk.
https://www.coindesk.com/lawmaker-wants-new-york-state-to-pilot-local-
cryptocurrencies/.
58 Mougayar, W. 10 June, 2017. Tokenomics — A Business Guide to Token
Usage, Utility and Value. Medium. https://medium.com/@wmougayar/
tokenomics-a-business-guide-to-token-usage-utility-and-value-b19242053416.
 BOX 5 The dimensions of the
Smart Contract blockchain revolution
ICOs are only one of a number of ways that
First articulated as a
blockchains can expand the space of possible
concept by Nick Szabo, a
smart contract is a piece economic relationships. Most of these new
of software that encodes possibilities will likely have their impact along two
the terms of a contractual dimensions of change, namely increased automation
agreement and automates and decentralization. In both cases, the changes and
a part or the whole of its new capabilities that blockchains enable will likely
observation, verification have impacts that spread beyond the economic sphere.
and/or performance.59
Because they are written Automation
in computer code, smart As with many other technological advances, some of
contracts have the ability
the most important implications of blockchain will flow
to be self-executing and
from the ways in which it enables automation. The
self-enforcing.60 All that
most significant way that blockchain will likely do this
is needed is for the smart
derives from how its creation of a digitally native value
contract to be provided with
the means of controlling system will enable the use of “smart contracts.”
the property implicated
Before getting too far into a discussion of smart
in the agreement, such
contracts, it is worth stepping back and considering
as programmable digital
assets or smart property what a traditional contract does. Currently, individuals
(that is, physical property or firms often create a contract to specify the
that can be controlled by parameters of an agreement between them. For
software) and connected to example, contracts will often describe the services or
the sources of information products being purchased, the prices that have been
– often called “oracles” – agreed to, and the schedule for payments to be made.
required by the terms of the Signing a formal written contract is meant to clarify
contract. obligations between parties and to provide proof of an
agreement that can be used to enforce compliance if
one party fails to meet their obligations.
34 | INSIDE THE BLACK BLOCKS

59 Szabo, N. 1996. Smart Contracts:

Building Blocks for Digital Markets. http://
www.fon.hum.uva.nl/rob/Courses/
InformationInSpeech/CDROM/Literature/
LOTwinterschool2006/szabo.best.vwh.
net/smart_contracts_2.html.
60 Investopedia. No date. “Smart
Contracts.” Investopedia. https://www.
investopedia.com/terms/s/smart-
contracts.asp.
Significantly, the signing of a contract does not written in computer code has the ability to
itself ensure compliance. Often services and remove much of the need for human intervention
products are delivered that do not meet the in enforcement from the practice of contracting.
agreed criteria, payments can be late and other
conditions can be breached. It is true that the Consider the following example. Bob purchases
existence of a contract entitles the parties to a car from Acme Motor Corp and agrees to
apply to courts and the state for enforcement of make payments of one ether every month for 36
the terms of the agreement, but doing so often months. Bob and Acme Motor Corp can formalize
involves lengthy and time-consuming litigation this agreement in a smart contract that runs on
or negotiations.61 Moreover, in countries where the Ethereum blockchain and links their digital
the rule of law is poorly observed, these problems wallets (the accounts that hold ether) and the car
often multiply and satisfaction can be difficult itself to the smart contract over the Internet. This
to obtain. Ultimately, contracting is always smart contract will monitor Bob’s payments and,
an imperfect exercise that, while it helps to should he miss one beyond the limit specified in
coordinate activities between counterparties and the smart contract, it could send a signal to the
reduce risk, serves only to reduce, not eliminate, car locking its doors and disabling its engine until
economic friction, risk and inefficiency. payments resume. Indeed, once autonomous
vehicles arrive, the smart contract could even
Smart contracts offer the possibility of further include a clause that commanded the car to
reducing this inefficiency and risk by increasing return itself to the dealership if the purchaser
predictability, thereby creating additional missed a sufficient number of payments.65
value.62 The creation of a digital value system
enables smart contracts to accomplish this Setting aside the non-blockchain technological
by expanding the boundaries of what can be innovations needed for this to occur (such as
automated by increasing the ability of a contract the development of autonomous vehicles) what
to directly exercise control over value.63 In other this scenario shows is how, by enabling smart
words, by writing the terms of a contract into contracts, many systems could be rendered
software that can directly perform these terms, much more efficient through the removal of
smart contracting can reduce the risks of non- intermediaries. For instance, in this case, the
compliance, while also increasing the speed and purchaser sets up a direct payment from their
efficiency of the execution of the agreements digital wallet to the car company – thereby
they implement.64 Essentially, a digital contract removing banks and credit card companies from
this transaction. Moreover, the combination
of smart contracts and smart property linked
61 Wright, A. and de Filippi, P. 12 March, 2015. Decentralized
Blockchain Technology and The Rise of Lex Cryptographia. SSRN.
to this arrangement could remove the need
Page 25-26. for intermediaries like collections agencies to
62 Szabo, N. 1996. Smart Contracts: Building Blocks for
Digital Markets. http://www.fon.hum.uva.nl/rob/Courses/ hound the purchaser and repossess the car if
35 | THE MOWAT CENTRE

InformationInSpeech/CDROM/Literature/LOTwinterschool2006/ the purchaser was ultimately unable to pay.

szabo.best.vwh.net/smart_contracts_2.html.
63 Nick Szabo refers to this as an “embedding” of the contract
in the world. http://www.fon.hum.uva.nl/rob/Courses/
InformationInSpeech/CDROM/Literature/LOTwinterschool2006/ 65 In principle, these smart contracts need not benefit only large
szabo.best.vwh.net/smart_contracts_2.html. corporations. Smart contracts could also be created to enforce a
64 Wright, A. and de Filippi, P. 12 March, 2015. Decentralized car’s warrantee, thereby saving customers the need to badger an
Blockchain Technology. Page 25. unresponsive manufacturer in order to have their rights enforced.
 By extension, this could also enable the firms Blockchains offer critical functionality in this
financing car purchases to lower the cost of regard. Recall that one of the key problems that
financing because the costs associated with blockchains were created to solve was to enable
defaults would be reduced. This reduction in the transactions – and, by extension, collaboration
onerousness of financing might in turn lower the – between anonymous entities in a trustless
number of defaults thereby creating a virtuous environment. This is exactly the situation that
circle. By removing financial institutions from the will likely confront many autonomous devices
equation, however, these smart contracts would as they seek to interact with other anonymous
also result in lost jobs. autonomous devices – and humans – in the real
world. Currently, we use economic value, and
The implications of smart contracting are even exchanges thereof, as a means of coordinating
more striking because of how, by enabling the allocation of scarce resources. Because
this sort of automation, digitally native value of how blockchains enable the creation of
systems could enable robots to begin contracting smart contracts capable of controlling digitally
with each other autonomously. In so doing, native forms of value, one can imagine the
blockchains may provide one of the critical establishment of dedicated blockchains
technological advances that enables the supporting self-contained digital markets
mainstreaming of the IoT. in a host of different contexts within which
autonomous devices would be able to interact
Currently, despite significant hype, the IoT has not
and efficiently allocate scarce resources. In so
yet noticeably impacted most people’s daily lives.
doing, these automated markets could play the
There are a variety of reasons for this but some of
role of hyper-efficient coordination mechanisms
the most important obstacles could be dissolved
that would likely generate significant new value.
by the capabilities that blockchains offer. For
example, IBM has suggested that blockchains will
Why not just use a credit card?
be essential to the deployment of the IoT because
One might ask why some of the examples, such
centralized command and control systems will
as Bob’s car payments, require a blockchain
be too complex, and by extension expensive and
to function. Could not such a contract be
insecure, to maintain effectively when hundreds
programmed on existing technology? Perhaps
of billions, perhaps trillions, of devices will need
it could: things that look a bit like smart
to be connected remotely to these systems.
contracting, such as algorithmic trading on the
Control will need to be decentralized and that
stock market, do already exist. Nonetheless, a
likely means that the devices in question will need
number of important obstacles stand in the way
to be autonomous – at least to a certain degree.66
of existing technologies supporting the mass
proliferation of such systems.
36 | INSIDE THE BLACK BLOCKS

The most obvious of these obstacles is cost,

something that is often a function of the presence
of intermediaries. Currently, there are limited ways
of transferring value electronically and they tend
66 Pureswaran, V. and Brody, P. with Cohn, J. Finn, P. Nair, S. to feature relatively high costs – especially when
Panikkar, S. 2015. Device democracy: Saving the future of the Internet
of Things. IBM Institute for Business Value. Slides 3-5 and 7. one considers the fees that intermediaries like
banks and credit card networks charge both the micropayments directly to artists every time they
customer and the merchant. One estimate made access their content instead of to intermediaries
in 2016 suggested that the fees incurred carrying like record labels, iTunes or Spotify.69
out a Bitcoin transaction were 5.5 times lower
It is difficult to imagine how existing credit
than the same fees that would have been incurred
card-based payment systems would be able to
using a credit card.67
handle the volume of payments required to make
The question of fees charged by intermediaries is these sorts of implementations possible. While
an especially important one because some of the it is true that the most important blockchains
more innovative implementations of blockchain currently have lower throughput capacity than
that have been theorized would depend heavily credit card networks,70 upgrades – such as the
on micropayments, often being made extremely use of state channels or ensuring interoperability
frequently. In order for such implementations between multiple blockchains – are already well
to be viable, high transaction throughputs at into development and testing.71 More important,
very low cost would be necessary. For instance, however, is the idea that blockchain technology
some have suggested that blockchains could could enable local or implementation-specific
help to enable the implementation of smart blockchains to be created and optimized –
electricity grids in which independently-owned relatively cheaply and flexibly on a per-project
but autonomous home solar panel electricity basis – in ways that simply would not be possible
generating systems negotiate with each other for the systems utilized by legacy payment
and the larger grid, trading power between systems.72
them in real time.68 For these grids to function
efficiently, a secure system capable of processing
payments valued at the level of micro-cents
multiple times a second would be necessary.
Similarly, many have suggested that blockchains
69 Tapscott, D. and Tapscott, A. 22 March, 2017. “Blockchain
might enable revolutionary new forms of digital Could Help Artists Profit More from Their Creative Works.” Harvard
rights management for digital assets such as Business Review. https://hbr.org/2017/03/blockchain-could-help-
artists-profit-more-from-their-creative-works.
music based on the concept of ‘metered’ access 70 Overcoming the hurdle posed by “scalability” remains an
important challenge for public blockchains like Bitcoin and
to content that would involve users making
Ethereum. For example, Bitcoin can currently only process
somewhere between 3.3 and 7 transactions per second, while
67 Hayes, A. 13 September, 2016. “How Much Cheaper are Visa claimed in 2016 that its VisaNet system could process up to
Bitcoin Fees than Credit Card Fees?” Investopedia. https://www. 65,000 transactions per second. See https://usa.visa.com/dam/
investopedia.com/news/how-much-cheaper-are-bitcoin-fees- VCOM/download/corporate/media/visanet-technology/visa-net-
credit-card-fees/. Even at the height of the cryptocurrency frenzy in fact-sheet.pdf.
December 2017 and January 2018, fees on the bitcoin blockchain 71 State channels are a mechanism whereby transactions can
remained comparatively low. For example, on 22 December, be carried out directly between parties without the need for
2017, the median fee paid to have a transaction processed was the transactions to be conducted on the blockchain, thereby
$31.71 (USD) and the median value transacted was $3,814 (USD) reducing the burden they impose on the network. Integrity of
suggesting that the median rate being paid to transact on the the transactions is guaranteed by a sort of “emergency break”
37 | THE MOWAT CENTRE

network was about 0.8 per cent – still significantly lower than which enables any of the parties involved to unilaterally move
the standard fees charged by the major credit card networks. See the transaction onto the blockchain at any time in a way that
https://bitinfocharts.com/comparison/bitcoin-median_transaction_ ensures that cheaters will not be rewarded. For a more in-depth
fee.html. explanation, please see Stark, J. 28 August, 2017. “Making Sense
68 Kishewitsch, S. June 2017. “The promise of blockchain in of Cryptoeconomics.” L4 Media. Medium. https://medium.com/l4-
distributed energy.” News. Association of Power Producers of media/making-sense-of-cryptoeconomics-c6455776669.
Ontario. https://magazine.appro.org/news/ontario-news/5166- 72 Kishewitsch, S. June 2017. “The promise of blockchain in
1498093738-the-promise-of-blockchain-in-distributed-energy.html. distributed energy.”
 Nonetheless, Ludwin still sees significant value
Decentralization
in blockchains because of how decentralization
The second main dimension along which creates what is referred to in the blockchain
blockchain enables innovation and change community as “censorship resistance.”
is decentralization. As discussed earlier, Censorship resistance is a term that refers
decentralization is one of the key characteristics to a system’s imperviousness to unilateral
of blockchain technology. But, unlike automation, alteration or control by a third party. In the case
the opportunities offered by decentralization can of Bitcoin, this means that no third party can
take more time to appreciate. Indeed, beyond the unilaterally intervene to stop a transaction from
fact that decentralization makes blockchains being completed on the network. In the case of
possible and that it increases their resilience Ethereum, it means that no entity can unilaterally
and security, the most obvious implication of halt the performance of a smart contract running
blockchain’s decentralization is that it creates on the platform.74
redundancy and inefficiency in systems that
use blockchain. This inefficiency is often cited Censorship resistance is not important for
as a problem for the expansion or scalability of everyone or at all times. To understand how it can
blockchain-based systems like Bitcoin. In fact, become important, it is worth examining a recent
Adam Ludwin, an entrepreneur working in the case where a centralized intermediated system
blockchain industry argues that “on almost every engaged in censorship of its users. In 2010, all
dimension, decentralized services are worse than major credit card companies, as well as Paypal,
their centralized counterparts: refused to allow payments to Wikileaks over their
networks, a move likely taken under pressure
»» They are slower
from the US government after Wikileaks released
»» They are more expensive
thousands of classified and secret US military
»» They are less scalable and diplomatic documents.75 While many might
»» They have worse user experiences applaud these firms for taking these actions on
»» They have volatile and uncertain governance.”73 the grounds that Wikileaks was irresponsibly
releasing government secrets, many early Bitcoin
adopters would likely see this as exactly the kind
of authoritarian government action that Bitcoin
was created to frustrate.
38 | INSIDE THE BLACK BLOCKS

74 This statement is true but obscures a slightly more

complicated reality. See the discussion of “The DAO” in Section 6.
75 Poulson, K. 12 April, 2010. “PayPal Freezes WikiLeaks Account.”
Wired. https://www.wired.com/2010/12/paypal-wikileaks/;
Greenberg, A. 7 December, 2010. “Visa, MasterCard Move To
73 Ludwin, A. 16 October, 2017. “A Letter to Jamie Dimon.” Choke WikiLeaks.” Forbes. https://www.forbes.com/sites/
Chain. Medium. https://blog.chain.com/a-letter-to-jamie-dimon- andygreenberg/2010/12/07/visa-mastercard-move-to-choke-
de89d417cb80. wikileaks/#522954382cad.
Another example of the importance of central bank control of fiat currency was strong.80
censorship resistance can be found in the current Many believe that the key motivation behind
enthusiasm for ICOs. As was discussed earlier, Bitcoin’s creation was to create a currency that
ICOs have exploded in popularity and, in 2017, no entity could manipulate and debase in the
attracted over $3.2 billion (USD) in investment. 76
ways that governments and central banks have
In fact, in 2017, ICOs provided more funding for often done throughout history.81 In fact, it is often
Internet firms than did traditional early-stage said that Bitcoin first became popular in the
venture capital. The funding for many of these
77
places that needed it least because ensuring that
projects would not have been available but for a currency is censorship resistant is not a priority
blockchains because the alternative platforms, for many in a country like Canada where citizens
such as stock markets, would decline to list them have benefited from a competent, professional
and traditional investors would decline to fund and independent central bank.82
them.78 Setting aside the question of whether this
is positive or not, the fact that blockchains like But cypherpunks’ concerns resonate powerfully
Ethereum are enabling ICOs, and that there is little with those who have seen their life savings wiped
regulators can do to stop them, demonstrates out by hyperinflation, have had them forcibly
the extent to which blockchains are censorship converted into a new currency, or had access
resistant.79 to their savings restricted by capital controls
imposed by the government in places such
A more fundamental form of censorship
resistance can be illustrated with a comparison
between cryptocurrencies and fiat currencies.
Blockchain was first proposed in the 80 Indeed, sometimes these ideas can get a little strange: Pearson,
“cypherpunk” community where resentment of J. 29 September 2017. “Inside the World of the ‘Bitcoin Carnivores’.”
Motherboard. Vice. https://motherboard.vice.com/en_us/article/
ne74nw/inside-the-world-of-the-bitcoin-carnivores.
76 The Economist. 9 November, 2017. “The meaning in the 81 See for instance, Spiralus. 23 March, 2017. Satoshi’s
madness of initial coin offerings.” Incomplete Economic Vision. Medium. https://medium.com/@
77 Kharpal, A. 9 August, 2017. “Initial coin offerings have raised Spiralus/satoshis-incomplete-economic-vision-eb833a33bcb5 and
$1.2 billion and now surpass early stage VC funding.” CNBC. Liu, A. 16 January, 2014. “What Satoshi Said: Understanding Bitcoin
https://www.cnbc.com/2017/08/09/initial-coin-offerings-surpass- Through the Lens of Its Enigmatic Creator.” Motherboard Blog. Vice.
early-stage-venture-capital-funding.html. https://motherboard.vice.com/en_us/article/vvbm43/quotes-from-
78 Ludwin, A. 16 October, 2017. “A Letter to Jamie Dimon.” satoshi-understanding-bitcoin-through-the-lens-of-its-enigmatic-
79 The case of Plexcoin, one of the few ICOs where regulators creator.
have taken action, is instructive in this regard. Despite ordering 82 Popper, N. 29 April, 2015. “Can Bitcoin Conquer Argentina?” The
Dominic Lacroix, its creator, to not go ahead with his planned New York Times Magazine. https://www.nytimes.com/2015/05/03/
ICO, Lacroix was still able to launch his ICO and collect more magazine/how-bitcoin-is-disrupting-argentinas-economy.html
than $15 million dollars from investors before he was arrested Similarly, The creation of basic banking services for the world’s 5
and sentenced to jail time. Had Lacroix attempted to conduct a billion unbanked individuals, something that has proven difficult or
traditional IPO, the regulator would have been able to ensure that unattractive to traditional providers because of its low margins and
PlexCoin never hit the market. Pearson, J. 8 December, 2017. limited profitability, is often touted as a potentially transformative
“PlexCoin Scam Founder Sentenced to Jail and Fined $10K.” application of blockchain that could make a material contribution
Motherboard. Vice. https://motherboard.vice.com/en_us/article/ to improving the lot of the world’s poor. Vigna, P. and Casey, M.
qvzkx7/plexcoin-scam-founder-sentenced-to-jail-and-fined-10k 2016. The Age of Cryptocurrency. Page 186. Another example
39 | THE MOWAT CENTRE

and Bergeron, Y. 8 December, 2017. “Le créateur d’une monnaie would be to provide reliable access to secure property rights for
virtuelle condamné à la prison.” ICI * Quebec. http://ici.radio-canada. the two-thirds of the world’s population that currently live without
ca/nouvelle/1071971/peine-prison-createur-monnaie-virtuelle- them. See Vigna, P. and Casey, M. 2016. The Age of Cryptocurrency.
dominic-lacroix It is also interesting to note that the only reason Page 216-217. and Arsenault, C. 1 August, 2016. “Property rights
that Lacroix was caught and stopped was because he was charged for world’s poor could unlock trillions in ‘dead capital’: economist.”
by a Canadian authority while he was physically in Canada. More Reuters. https://www.reuters.com/article/us-global-landrights-
concerning are fraudulent ICOs launched from foreign jurisdictions desoto/property-rights-for-worlds-poor-could-unlock-trillions-in-
where enforcement of Canadian laws may be impossible. dead-capital-economist-idUSKCN10C1C1.
 as Zimbabwe,83 Argentina,84 Venezuela85 and dollar bug bounty, and no one’s hacked it. It feels
Greece. While Bitcoin is known for its own price
86
like pretty good proof [that it is secure].”88
volatility, this volatility is arguably the result of its
immaturity as an asset and will likely decrease Finally, some are arguing that the importance
as it matures and grows more widespread.87 of decentralization is actually much more
Conversely, inflation in a country like Zimbabwe abstract and fundamental. Those who make this
is the direct and predictable result of the argument hold that the decentralization enabled
government’s reckless decision to print money by blockchain is an essential corrective to a flaw
to pay its debts. Inflation of this type would be in the current evolutionary path of the Internet.
impossible in an economy that used only Bitcoin According to this argument, the lack of a protocol
because the number of bitcoins is transparently for personal identification on the Internet has
controlled by the Bitcoin software and resistant enabled the centralization of control over the
to unilateral change (i.e. censorship) by a self- Internet into the hands of a small group of mega-
interested party – like a profligate government companies with negative results for competition,
looking to print its way out of its debts. users’ health and democracy.89 In combination
with several other technologies, blockchain could
Decentralization also helps make blockchains enable society to disintermediate these firms,
reliable and secure. We have already discussed help to return the Internet to its decentralized
how blockchains enable greater reliability origins and re-empower individuals by enabling
because of how they eliminate single points them to own and better protect the data and value
of failure. Similarly, by avoiding the creation of they create.90
“honeypots,” the use of a blockchain can increase
security. Chris Dixon, a venture capitalist active
in the blockchain industry, illustrates this point
by comparing the value hosted on the biggest
blockchains to a “bug bounty” – that is, the
reward software firms will pay to hackers who
inform them of vulnerabilities in their software.
He notes that if someone were able to hack any of
the big blockchains, the monetary reward would
be immense – potentially worth billions of dollars.
But, “Bitcoin is now a nine-year-old multibillion-

83 Titcomb, J. 20 November, 2017. How bitcoin has become

Zimbabwe’s crisis currency. The Telegraph. http://www.telegraph.
co.uk/technology/2017/11/20/bitcoin-has-become-zimbabwes-
crisis-currency/.
40 | INSIDE THE BLACK BLOCKS

84 Popper, N. 29 April, 2015. “Can Bitcoin Conquer Argentina?”

85 The Associated Press. 13 December, 2017. “Bitcoin boom seen 88 Johnson, S. 16 January, 2018. “Beyond the Bitcoin Bubble.”
as survival, not speculation, in Venezuela.” News. CBC. http://www. 89 The Economist. 18 January, 2018. “How to tame the tech
cbc.ca/news/world/venezuela-bitcoin-1.4447568. titans.” The Economist. https://www.economist.com/news/
86 The Associated Press. 29 June, 2015. “Greece in limbo as it leaders/21735021-dominance-google-facebook-and-amazon-bad-
shuts banks, puts limits on cash withdrawals to avoid financial consumers-and-competition-how-tame.
collapse.” 90 Mainelli, M. 5 October, 2017. “Blockchain Could Help Us
87 Murphy, H. 27 November, 2017. “Bitcoin stirs volatility fears Reclaim Control of Our Personal Data.” Harvard Business Review.
as it heads for $10,000.” The Financial Times. https://www.ft.com/ https://hbr.org/2017/10/smart-ledgers-can-help-us-reclaim-
content/23392588-d398-11e7-8c9a-d9c0a5c8d5c9. control-of-our-personal-data.
 One critical question
that governments
must constantly ask
themselves is whether
a blockchain is
necessary or whether
a simpler DLT –
or even a traditional
database –
will suffice.
41 | THE MOWAT CENTRE
 4
POTENTIAL USES
BY THE BROADER
PUBLIC SECTOR
Some of the most interesting potential use cases for blockchain lie within the broader public sector.
These use cases – which range from enabling greater effectiveness, patient control and privacy of
medical records, to creating a reliable and accessible public record of individuals’ academic credentials
to improving the efficiency of government business permit issuing and licensing regimes – all offer
governments the possibility of improved transparency, efficiency and effectiveness.

Nevertheless, all of these applications are still in

the early stages and significant work remains to Electronic health records
be done to ensure that any new solutions offer In the past few years a number of proposals for
worthwhile improvements on existing systems. using blockchain to improve electronic health
Blockchain is not a solution to all problems – or records (EHRs) have emerged. While initially
even most problems for that matter. One critical pursued out of a desire to simply improve
question that governments must constantly ask efficiency, EHRs are now also being seen as a
themselves is whether a blockchain is necessary means of giving patients greater control over their
or whether a simpler DLT – or even a traditional own health and medical treatments, something
database – will suffice. In many cases, DLT and that is attractive from a privacy perspective but
traditional databases will serve the government’s also because doing so seems to improve patients’
purpose more efficiently and effectively. health outcomes.91 Existing EHR systems aim
to further these objectives, but for a variety of
Nevertheless, even with this healthy scepticism,
reasons including rigorous privacy requirements,
blockchain offers governments numerous
poor interoperability, incompatible workflow
functionalities that could help them improve
designs and poor audit trails they have failed to
their operations. Consequently, they should
deliver many of the sought-after improvements.92
seize opportunities to experiment with potential
uses of blockchain technology when they
42 | INSIDE THE BLACK BLOCKS

can. This section highlights three areas that

hold significant promise or in which some 91 The Economist. 1 February, 2018. “A revolution in health care
governments are already active. is coming.” The Economist. https://www.economist.com/news/
leaders/21736138-welcome-doctor-you-revolution-health-care-
coming.
92 Halamka, J. Lippman, A. Ekblaw, A. 3 March, 2017. “The
Potential for Blockchain to Transform Electronic Health Records.”
Harvard Business Review. https://hbr.org/2017/03/the-potential-for-
blockchain-to-transform-electronic-health-records.
The solution offered by blockchain would be
to use a blockchain to create an overarching Professional and post-
mechanism that would provide patients with a secondary credentials
means of linking all their records, regardless of
where they are stored, controlling who gets to Another area that offers a potentially important
see them, and tracking their use. Critically, the use case for blockchain is in professional and
EHRs themselves would probably not be put post-secondary accreditation. Currently, it can
on the blockchain as is sometimes confusingly be frustrating, time-consuming and costly for
suggested. Rather, the records would remain at individuals to prove that they hold the credentials
the institution, be it a clinic or hospital, where that they claim to hold. Conversely, it can be just
they currently reside, but access to these robustly as difficult for individuals to reliably confirm that
encrypted records would only be possible through other individuals hold the credentials they claim
a portal created by a blockchain. Access to the to hold. Many institutions that require individuals
records would be controlled by the patient via to prove that they hold a credential still require
the blockchain, and any access to the records them to do so by providing an original or validated
would be tracked by the blockchain as would any physical copy of the credential.
additions made to it.
The process of proving one’s credentials can be
The creation of a common, public, likely open- inefficient and costly, especially for refugees and
sourced, EHR blockchain platform would provide skilled immigrants who otherwise need to go
a single simplified focus for efforts to build through extensive testing to have their credentials
compatibility into a system riddled with poor recognized or to establish new credentials.94 It
interoperability. It could also conceivably enable can also be frustrating for students – especially
massive new medical breakthroughs by providing international students – who may be required
machine learning algorithms with a means of to purchase multiple copies of their transcripts
using transparent, open source smart contracts or degree certificates from universities when
to query millions of EHRs for specific pieces of they need them to apply for additional schooling,
information without compromising the privacy scholarships or jobs. Moreover, it is difficult to
of these records. In so doing, this could unlock reliably demonstrate the authenticity of many
enormous new datasets for these algorithms to of these physical documents, making them
mine for new discoveries and identify candidates vulnerable to fraud.
for medical trials, potentially saving thousands of
lives and billions of dollars.93 43 | THE MOWAT CENTRE

94 The use of blockchain to overcome this problem is

already being piloted: World Education Services. 30 May,
93 See, for example, the proposal contained in Shrier, A. Chang, 2018. “World Education Services Pilots Blockchain-Based
A. Diakun-Thibault, N. Forni, L. Landa, F. Mayo, J. van Riezen, R. Digital Badges for Internationally Educated Students and
Hardjono,T. Blockchain and Health IT: Algorithms, Privacy, and Data. Professionals.” Globenewswire. https://globenewswire.com/news-
White Paper prepared for Office of the National Coordinator for release/2018/05/30/1513818/0/en/World-Education-Services-
Health Information Technology U.S. Department of Health and Pilots-Blockchain-Based-Digital-Badges-for-Internationally-
Human Services. Educated-Students-and-Professionals.html.
 The solution offered by blockchain or DLT would
be for the credential granting institutions – Government permits,
such as universities, colleges or professional licensing and “verifiable
associations – to jointly operate a permissioned
blockchain on which they issued the credential claims”
granted to an individual in the form of a digital Finally, blockchain may prove extremely useful
token. Individuals who received these credentials in improving the efficiency of government permit
would be able to add the token to their digital granting, licensing and the provision of what
wallet. If another institution or potential employer are referred to as “verifiable claims” such as an
wanted to check an individual’s credentials, the individual’s date of birth.
individual could simply provide the institution or
employer with their wallet address for them to One of the most fundamental problems this
query at any time. could solve would be to reduce the burden of
interacting with government or complying with
Not only would such a system increase efficiency, regulations currently faced by individuals and
it would also make degree fraud much more businesses. Indeed, individuals and businesses
difficult. This may seem like a small benefit, often complain that they are forced to waste
but some experts claim that as many as half a significant amount of time by repeatedly
of all PhDs issued in the USA each year come providing different parts or levels of government
from fraudulent degree mills.95 Considering that with the same information that they have already
credential requirements often play important roles provided to other parts or levels of government.97
in ensuring public safety and accountability for Not only is this inefficient, it creates a greater
credential holders, such a system could reduce likelihood that this information will be hacked or
some of the significant, but often unnoticed, corrupted through human error or technological
harmful impacts of credential fraud.96 failure because it is being transmitted and
physically entered into multiple systems multiple
times.

Blockchain offers a real opportunity to reduce

some of these burdens for individuals and
business. The Government of British Columbia’s
Verified Organization Network (VON) represents
a good example of how governments could
use blockchain in this way. The provincial
government’s plan for VON is for government
44 | INSIDE THE BLACK BLOCKS

permits and other “verifiable claims” to be pre-

loaded onto the system so that other government
95 Szeto, E. Vellani, N. “‘All of us can be harmed’: Investigation
reveals hundreds of Canadians have phoney degrees.” Marketplace.
services can query the VON’s digital wallet,
CBC. http://www.cbc.ca/news/business/diploma-mills- called TheOrgBook, to verify information about
marketplace-fake-degrees-1.4279513.
96 Johnson, E. 11 September, 2017. “‘I am devastated’: Toronto
lawyer out $100K after hiring fraudster with fake law degree.” 97 Johal, S. and Urban, M. 11, May, 2017. Regulating Disruption:
Go Public. CBC. http://www.cbc.ca/news/business/fake-toronto- Governing in an era of rapid technological change. The Mowat Centre.
lawyer-defrauds-clients-1.4276157. https://mowatcentre.ca/regulating-disruption/.
organizations on the network. Eventually, the Additionally, the project also included using
ambition is for organizations like businesses an Ethereum test network to simulate how an
to have their own wallets to hold their verifiable external entity – e.g., a bank evaluating a loan
claims so that they will be able to prove their request from a potential restaurateur – might
credentials to others themselves. 98
access a public blockchain linked to a private
government one to confirm that the applicant
In another similar example, the Government of had acquired the permits needed to open their
Canada, the Government of Ontario and the City restaurant. The manner in which the blockchain
of Toronto recently concluded a proof of concept was used, and the changes in the processes that
in which they explored how blockchain might be it enabled are illustrated in Figures 13 and 14.
used to improve the way governments interact
with someone seeking to open a restaurant. The proof of concept demonstrated that there
In this proof of concept, they created a test was significant scope for the use of blockchain
database that was shared between a variety to improve the efficiency of the current customer
of departments and agencies at the municipal journey from both the perspective of the applicant
and provincial level with each of these entities and the various levels of government. For the
operating one of the network’s nodes. This private customer, the use of blockchain or DLT in this
test database never contained real individuals’ or way could reduce the burden of travelling to
businesses’ information, but the database was many different government offices to acquire the
used to simulate the movement of information necessary permits and cut the time required to
needed to acquire a restaurant permit between do so from weeks to days. Note, for example, how
the following portals and systems of record: the number of steps a citizen is required to take
was cut from eight under the current system to
»» the Government of Ontario online portal used to
four in the proof of concept. For governments,
provide information and request incorporation
this sort of system could also help realize the
of a new business
ambition to create a more “client focused”
»» the Government of Ontario ONBIS registration approach to government services and also
system increase the integrity and security of the data
»» the Canada Revenue Agency Business Number involved while also reducing costs.
Registry System
Moreover, the proof of concept also demonstrated
»» the City of Toronto Licensing Office’s Progress that it would be possible to introduce a
Software Licensing System blockchain or distributed ledger as just one piece
that could help to connect the larger ecosystem
»» the Alcohol and Gaming Commission of Ontario
of legacy systems. This is an important point to
Computronix Regulatory Assurance System
note as it means that blockchain or DLT could be
implemented incrementally across the system
45 | THE MOWAT CENTRE

as appropriate and in line with the lifecycles of

existing legacy systems. In other words, a “Big
Bang,” in which the entire system is replaced with
98 O’Donnell, D. 18 April, 2018. “BCGov Verifiable Organization
Network – Impressive Client Demo.” Blog. Continuum Loop Inc. a single blockchain at enormous cost and with
https://www.continuumloop.com/bcgov-verifiable-organization- significant risk, would not be necessary.
network/.
 FIGURE 13
Current restaurant permit acquisition journey

Sara, who has never owned a business

before, wants to open a restaurant.
Follow Sara as she:

1 Opens an account
with the
ONBIS System
Provides the required information
so that she can:
1a
incorporate her business
register her business name
receive a CRA business number The ONBIS
System sends
a request to

2
the CRA BN
Registry
System.
The ONBIS system articles of incorporation
sends Sara her: business name registration
CRA business number

1b

3 Sara must now take

her new
documentation and:
visit the City of Toronto’s Licensing
Office in person to apply for a
preliminary zoning review and her
The CRA BN
Registry
municipal business license System
responds to the
request by
issuing a new

4 Once the Licensing Office

has physically verified her
documentation, if everything
is in order,
Sara is granted a municipal
business license and;
provided with a preliminary
CRA business
number and
sends it back
to the ONBIS
system.
zoning review

5 Sara must now: apply for a liquor sales license from the Alcohol and
Gaming Commission of Ontario (AGCO) by either
mailing the documentation she has acquired or taking
it with her as she visits the AGCO’s offices in person.

6 Once the AGCO has

physically verified her
documentation, if
Sara is granted a
liquor sales license

everything is in order,
46 | INSIDE THE BLACK BLOCKS

7 After Sara has accumulated

this documentation, she can
now:
visit a bank in person to
present it as a part of her
application for a loan.

8 Sara receives her loan and

can now set up her
restaurant.
FIGURE 14
Potential restaurant permit acquisition journey

Sara, who has never owned a business

before, wants to open a restaurant.
Follow Sara as she:

1a
1 Sara opens an
When the application is
completed and has been
Data Exchange
Blockchain and smart contracts or
other distributed ledge technology
account with the submitted it is automatically
Single Window imported into the Data
Interface and Exchange. 1b
provides the required
information. After the smart contracts on the Data Exchange
have scanned Sara’s application, they recognize
that it should be sent to the ONBIS system so that
The Single Window Interface: Sara’s business can be incorporated and the
scans the application 1c business name registered.

identifies all the permits that

will be required With the business now

ensures that Sara has provided

incorporated and the business
name now registered, ONBIS
1d
all the required information sends Sara’s application back to After the smart contracts on the Data Exchange
the Data Exchange. have scanned the incomplete application, they
recognize that it must now be sent to the CRA BN
Registry System.

2 Sara is notified by the

1e
After reviewing her application
1f
After the smart contracts on the Data Exchange
have scanned Sara’s application, they recognize that
Single Window and granting Sara a business it should now be sent to the City of Toronto to
Interface that her number, the CRA BN Registry receive a municipal business license and a
application has been preliminary zoning review.
System sends Sara’s application
processed and that back to the Data Exchange.
she has been granted
all the permits she
requires.
1h
1g After the smart contracts on the
data exchange have scanned the incomplete
application, they recognize that it must now be sent
After reviewing her application to the Alcohol and Gaming Commission of Ontario
and granting Sara a municipal (AGCO) to receive a liquor sales license.

3
business license and a
preliminary zoning review,

Sara visits a
Sara’s application is sent back
to the Data Exchange.
1j
bank branch After the smart contracts on the Data Exchange
to apply for a have scanned the now complete application, they
loan. recognize that Sara can be notified that she has

1i received all the required permits.

After reviewing her application and

granting a liquor sales license,

4
Sara’s application is sent back to
the Data Exchange. 3b
47 | THE MOWAT CENTRE

Sara receives After scanning its records for verification, the Data
her loan and
can now set up
3a Exchange sends the bank confirmation that Sara
possesses all the required permits.
her restaurant. The bank sends an inquiry to the
Data Exchange to determine if
Sara has the permits required to
open the business associated with
her loan application.
 The proof of concept also demonstrated that In this respect, proofs of concept and small scale
while there would be some technical issues to pilot projects represent excellent opportunities to
overcome, the largest challenges in implementing advance multiple objectives. As just mentioned,
a blockchain solution would likely lie elsewhere. they can be leveraged to help build internal
Specifically, while the blockchain itself would be government capacity without raising the
tamper-proof and easily audited, it would only stakes too high. Significantly, these benefits
be as good as the information added to it by the are also applicable for small and medium-sized
participating departments and agencies and enterprises as well. These opportunities can
the security of the processes by which these provide small and medium-sized blockchain
additions were made. The type of data structures enterprises – of which there are many based
used on the blockchain, the organizations allowed locally in Ontario and elsewhere in Canada – with
to operate a node, the question of how new experience working with governments at a scale
organizations would be on-boarded – all of these which is comfortable for them. This procurement
questions would need to be resolved prior to experience can be especially valuable for firms
implementation. Additionally, certain regulatory who often complain of an inability to attract
and legislative requirements that are not critical institutional reference customers, even as
technologically neutral may have to be changed they help to set up the government organizations
before a blockchain or DLT-based solution could involved for future projects of greater scope and
be implemented. ambition.

On the human side, an external consultant was Overall, the proof of concept demonstrated
contracted to provide much of the technical that there are real use cases for blockchain in
know-how for the proof of concept. While government operations, especially as a means of
some government employees were able to take encouraging and enabling cooperation between
advantage of the project and use it as a learning different departments, agencies and levels of
opportunity, getting to a point where government government that need to exchange information
has sufficient in-house blockchain capacity to or verify claims with each other regularly. The
tackle more ambitious projects will take time, proof of concept also demonstrated that there
both on the technical and policy sides. could be significant benefits for the public should
this technology be implemented by government
in areas where there was a need for the public
to be able to access data or prove a verifiable
claim, such as their possession of a restaurant
permit. But it also demonstrated that there
are significant obstacles on the path towards
48 | INSIDE THE BLACK BLOCKS

the implementation of an actual operational

blockchain solution in government in Canada.
5 IMPLICATIONS FOR
PUBLIC POLICY
Blockchain is still a young technology and its implications for public policy are still unclear.
Nevertheless, understanding how blockchain works, how it will enable more automation and
decentralization and how it might impact government operations can help to reduce this uncertainty.
Building on this analysis, the following section identifies four broad “Issues to Watch” which are likely to
have important impacts in the context of public policy.

Competition in “governance services”

Many services that governments provide could land registry system onto a blockchain.101 Sweden
conceivably be better delivered using blockchain recently completed a pilot project along similar
or DLT. In some places this is already occurring. lines.102 The government of Dubai has said that
The most obvious instance are in countries that it wants all visa applications, bill payments and
lack stability or effective rule of law. For example, license renewals – processes which account
in countries where the government has failed to for over 100 million documents per year – to
provide a stable currency (such as Venezuela 99
be transacted on blockchains by 2020.103 Each
and, previously, Argentina100), many citizens of these projects have unique motivations
are turning to, or have previously turned to, and contexts, but overall, the idea is that the
cryptocurrencies. combination of transparency and immutability

Blockchains are also being used in other less

extreme circumstances to provide governance 101 Shin, L. 7 February, 2017. “The First Government To Secure
Land Titles On The Bitcoin Blockchain Expands Project.” Forbes.
services – often with governments playing https://www.forbes.com/sites/laurashin/2017/02/07/the-first-
a leading role. In 2017 the Eastern European government-to-secure-land-titles-on-the-bitcoin-blockchain-
expands-project/#1f4ecc134dcd; The Economist. 1 June, 2017.
country of Georgia began shifting its national Governments may be big backers of the blockchain. The Economist.
https://www.economist.com/news/business/21722869-anti-
establishment-technology-faces-ironic-turn-fortune-governments-
may-be-big-backers.
102 Haaramo, E. 5 July, 2017. “Sweden trials blockchain for
49 | THE MOWAT CENTRE

land registry management.” ComputerWeekly.com. https://www.

computerweekly.com/news/450421958/Sweden-trials-blockchain-
for-land-registry-management.
103 D’Cunha, S. 18 December, 2017. Dubai Sets Its Sights On
99 Chun, R. September, 2017. “Big in Venezuela: Bitcoin Becoming The World’s First Blockchain-Powered Government.
Mining.” The Atlantic. https://www.theatlantic.com/magazine/ Forbes. https://www.forbes.com/sites/suparnadutt/2017/12/18/
archive/2017/09/big-in-venezuela/534177/. dubai-sets-sights-on-becoming-the-worlds-first-blockchain-
100 Popper, N. 29 April, 2015. “Can Bitcoin Conquer Argentina?” powered-government/#4a56a414454b.
 offered by blockchains could help to improve the The most noticeable results of the X-road-led
efficiency of government operations, the ease of digitization of government in Estonia have
citizens’ interactions with their governments, and been the significant increases in administrative
reduce opportunities for corruption. convenience and efficiency it has enabled. The
Estonian government claims to have saved
The Baltic country of Estonia is arguably the the equivalent of 2 per cent of GDP a year in
country that is the furthest along this path. Its government spending.
X-road information system enables residents
to do everything from viewing their medical But other more complex benefits also appear to
records, to paying their taxes, to voting online. 104
be emerging.107 For example, in 2014, Estonia
Since the X-road only links a number of separate launched something called e-residency, a program
centralized databases it is not itself a blockchain whereby non-Estonians can become “digital
according to our definition. 105
Nevertheless, it residents” of the country. E-residency, which
uses similar cryptographic techniques and DLT does not confer any special ability to actually
to track changes to shared databases by multiple immigrate to Estonia, enables e-residents to
collaborators, enable high levels of transparency access many of the services that Estonia’s
and provide differentiated access to information increasingly digital government offers such as
depending on permission levels. In fact, given the “remote management, lower cost of business
nature of government operations, Estonia’s X-road services, access to the EU market, and access to
may provide a better indication of what many of a wider choice of e-services.”108
the potential implementations of blockchain and
DLT by government will look like than do public As of December 2017, almost 27,000 applications
blockchains like Bitcoin.106 Thus, the Estonian for e-residency had been received from 143
experience offers a number of lessons and countries. At that time, e-residents had already
insights into how government services can be set up 4,272 companies in Estonia. Furthermore,
delivered more conveniently and efficiently using a 2017 report by Deloitte estimated that, in
these sorts of technologies. It also offers some its first three years of operation, Estonia’s
important warnings. e-residency program had generated €1.4 million
in government revenues and €13 million in
indirect socio-economic benefits. The same
report suggested that these revenues and indirect
benefits would likely rise to over €31 million and
€194 million respectively by 2021.109
50 | INSIDE THE BLACK BLOCKS

104 Jaffe, E. 20 April, 2016. “How Estonia became a global model

for e-government.” Side|Walk|Talk. Sidewalk Labs. https://medium. 107 Heller, N. 18 & 25 December, 2017. “Estonia, the Digital
com/sidewalk-talk/how-estonia-became-a-global-model-for-e- Republic.” The New Yorker. https://www.newyorker.com/
government-c12e5002d818. magazine/2017/12/18/estonia-the-digital-republic.
105 Birch, D. 29 March, 2017. “The mystery of the non-existent 108 https://medium.com/e-residency-blog/heres-why-tax-evaders-
Estonian digital identity blockchain: solved!” disruptive.asia. https:// are-disappointed-in-estonian-e-residency-2322644f5f59.
disruptive.asia/estonian-digital-identity-blockchain/. 109 Cavegn, D. (ed) 2 December, 2017. “Deloitte: E-residency
106 Note, for instance, the similarity of the X-road to the brought €14.4 million to Estonia in first three years.” News. eer.
Government of Ontario and City of Toronto proof of concept ee. https://news.err.ee/646254/deloitte-e-residency-brought-14-4-
outlined in Section 5. million-to-estonia-in-first-three-years.
 FIGURE 15
Estonia’s X-Road data exchange

Source: Vassil, K. June 2015. “Estonian e-Government Ecosystem: Foundation, Applications, Outcomes.” World Development Report
Background Paper. http://pubdocs.worldbank.org/en/165711456838073531/WDR16-BP-Estonian-eGov-ecosystem-Vassil.pdf. Page 12.

At the moment, the advantages of e-residency – especially for marginalized groups like women
that are often touted – such as the ability to use and especially when that business works across
digital signatures for all business interactions, borders – the program has been very attractive.
the ability to set up a company in hours instead Indeed, the e-residency program has partnered
of days or weeks, the speed and ease of filing with the United Nations (UN) to develop a
pre-populated smart tax forms and access to the project called “e-Trade for All” aimed at helping
EU market – may not seem overwhelming from individuals in developing countries to start an
a Canadian perspective.110 But for residents of online business using the e-residency program.111
some developing countries where regulations
can make it difficult to start and run businesses
51 | THE MOWAT CENTRE

110 The benefits are a bit more obvious for Briton’s who want
to operate a business in the EU in a post-Brexit world. Hardy, A.
Robinson, N. and Haggman, A. 18 November, 2016. “VISIT | How
to stay in.eu: A post-Brexit gift from Estonia and an evening inside 111 Godoy, D. 25 April, 2017. “UN and e-Residency join forces
its Embassy.” Geopolitics & Security. Royal Holloway; University of to empower entrepreneurs in the developing world.” Republic
London. https://rhulgeopolitics.wordpress.com/2016/11/18/visit- of Estonia E-Residency Blog. Medium. https://medium.com/e-
how-to-stay-in-eu-a-post-brexit-gift-from-estonia-and-an-evening- residency-blog/un-and-e-residency-join-forces-to-empower-
inside-its-embassy/. entrepreneurs-in-the-developing-world-ea834005f85e.
 More fundamentally, e-residency shows how the It is not difficult to imagine how a welcoming
digitization of Estonia’s governance services regulatory framework in a country like Estonia,
has created the infrastructure needed to enable combined with the ability to remotely administer
“government-as-a-platform.” 112
E-residency is just a company through a program like e-residency,
one example of how the creation of platforms like might appeal to entrepreneurs.116 Indeed, one can
this can enable the most unexpected innovations. see important parallels between this approach
(Indeed, the next big step for the e-residency and the strategy used by the US state of Delaware
program looks likely to be the launch its own to attract businesses to incorporate there in the
blockchain-based digital asset, the Estcoin. ) 113
twentieth century. By passing business friendly
Critically, however, innovation like this is not just laws, by ensuring its Court of Chancery – a law
the result of Estonia having built a technological court focused on business transactions – was
infrastructure. Rather, the construction of a staffed with the best judges available and by
corresponding “smart policy framework” 114
– the building up a robust business case law, Delaware
policy culture and infrastructure needed to get an managed, despite its small population (still less
optimal return from the technology and enable than a million), to become the legal US domicile
innovations like e-residency – has also been of about two-thirds of all Fortune 500 companies
essential. Overall, this smart policy framework (see Figure 15).117
has provided Estonia with a competitive head
Why is this important in the context of
start in the race to attract businesses and
blockchain? By creating a digitally native value
investment, as well as “residents,” to its outsized
system, blockchain is enabling the digitization
corner of the growing digital world.115
and automation of a vast new category
of activities. In so doing, it is empowering
individuals, firms and networks vis-à-vis the
state in new ways and reducing the extent
to which geography and borders can blunt
the competition that governments face. In
112 Government-as-a-platform is a concept patterned after other words, individuals, networks, firms and
the concept of Web 2.0. At its core, it refers to the idea that
governments in other jurisdictions now have the
government’s function is as a convenor or enabler of beneficial
forms of collective action. Thus, it refers to the idea that one of ability to compete with Canadian governments
government’s core functions is to enable private individuals and
groups to engage in beneficial activities that it would be difficult or
in the provision of governance services in ways
impossible to undertake without government support – and which that were simply not possible previously. With
government itself is unlikely or poorly suited to do. For example,
this often involves the creation of value through the leveraging
Bitcoin, a small network of individuals have
of government data, as with citizen science initiatives or in shown that they are capable of disrupting an area
building real-time transit tracking apps. See O’Reilly, T. “Chapter 2.
Government as a platform.” Open Government. http://chimera.labs. – currency issuance – that has basically been a
oreilly.com/books/1234000000774/ch02.html. state monopoly for at least a century. How might
52 | INSIDE THE BLACK BLOCKS

113 Korjus, K. 19 December, 2017. “We’re planning to launch

estcoin.”
114 Korjus, K. 7 July, 2017. “Welcome to the blockchain nation.”
Republic of Estonia E-Residency Blog. https://medium.com/e- 116 “Competition [between governments] is good. If you don’t offer
residency-blog/welcome-to-the-blockchain-nation-5d9b46c06fd4. good services, through e-residency, citizens will have options and
115 In another example, Estonians are also taking a leading role can choose a better digital government”. See https://twitter.com/
in grappling with the many legal issues that the development of AlexBenay/status/963166899314962432.
artificial intelligence will raise – they even have a hashtag for it: 117 Semuels, A. October 3, 2016. “The Tiny State Whose Laws
#krattlaw. Heller, N. 18 & 25 December, 2017. “Estonia, the Digital Affect Workers Everywhere.” The Atlantic. https://www.theatlantic.
Republic.” com/business/archive/2016/10/corporate-governance/502487/.
 FIGURE 16
Corporate domiciles of Fortune 500 companies in the USA
350

300

250
Number of companies

200

150

100

50

0
GA

MA

IA

PA

VA
WA
CA

FL

IL

KY

UT
CT

NY
IO
AR

DE

IN

MD

MI
MN

MO
NE
NV
NJ

NC
OH
OK
OR

TN
TX

WI
Federal
GA

Source: Semuels, A. October 3, 2016. “The Tiny State Whose Laws Affect Workers Everywhere.” The Atlantic. https://www.theatlantic.com/
business/archive/2016/10/corporate-governance/502487/.

governments respond if, for example, significant banking will not be disrupted tomorrow,120 the
portions of the economic activity occurring significance alone of such a possibility is so
under their jurisdiction came to be conducted in great that prudence demands that governments
a currency over which their monetary policy has build expertise in these new technologies and
essentially no effect? 118
consider how they might respond. Estonia and its
e-governance infrastructure are providing an early
While unlikely to occur in the short term,
and innocuous warning of how a government
challenges like these are not amenable to
that embraces digitization can out-compete less
quick solutions – governments need to begin
innovative governments. (Estonia has committed
considering responses to contingencies of this
to share all necessary tax information with the
nature well in advance.119 While fractional reserve
countries in which e-residents are physically
active.121) While the details of the challenges
presented by this increasingly competitive
environment are not yet clear, the trend in this
direction is.122
118 For a more substantive discussion of the tax-specific
implications of the transfer of value into digitally native value
systems – one that has already started to occur with the advent 120 Lagarde, C. 29 September, 2017. Central Banking and
of the “data economy” – see Johal, S. Thirgood, J. and Urban, M. Fintech—A Brave New World. International Monetary Fund.
with Alwani, K. and Dubrovinsky, M. 30 July, 2017. Robots, Revenues Presentation made to the Bank of England Conference. London.
& Responses: Ontario and the Future of Work. The Mowat Centre. https://www.imf.org/en/News/Articles/2017/09/28/sp092917-
https://mowatcentre.ca/robots-revenues-responses/. Pages 35-36 central-banking-and-fintech-a-brave-new-world.
53 | THE MOWAT CENTRE

and 38-41. 121 Anderson, J. 19 July, 2016. “One way to get around Brexit:
119 The Federal Reserve Bank of St Louis is already examining Become an e-resident of Estonia.” Quartz. https://qz.com/736004/
the potential problems such a situation could cause. Bullard, J. one-way-to-get-around-brexit-become-an-e-resident-of-estonia/.
14 May, 2018. Non-Uniform Currencies and Exchange Rate Chaos. 122 Hammersley, B. 27 March, 2017. “Concerned about Brexit?
Federal Reserve Bank of St Louis. Presentation made to Coindesk Why not become an e-resident of Estonia.” Wired. http://www.
Consensus 2018. New York City. https://www.stlouisfed.org/~/ wired.co.uk/article/estonia-e-resident. For an example of an effort
media/Files/PDFs/Bullard/remarks/2018/Bullard_Consensus_ to effectively challenge government’s monopolies on a number of
New_York_14_May_2018.pdf?la=en. governance services, visit https://bitnation.co.
 The arrival of the Internet and streaming audio
Decreasing and video services has dramatically undermined
effectiveness of the viability of this approach. Services like
Netflix and Spotify, which an already significant
“negative” regulatory and increasing proportion of Canadians use to
frameworks access content, have no obligation to include
Canadian content in their offerings and the CRTC
Another aspect of blockchain’s ability to empower and the Government of Canada have to date
individuals vis-à-vis the state that is worth found no way of forcing these services to create
watching concerns the declining effectiveness a guaranteed market for Canadian content. This
of existing regulatory frameworks which have is largely because these services are based in
traditionally relied on “negative” approaches. In other jurisdictions and are able to connect with
our usage, negative approaches are ones that their users directly via the Internet. Without
achieve their goals by removing or restricting restricting access to the Internet, something likely
the freedom of individuals within the system. unacceptable to the public, it is not clear how the
Positive approaches, conversely, seek to advance Canadian government could force these foreign
an objective without restricting the freedom of firms to abide by its current Canadian content
individuals. regime.

The undermining of the federal government’s The key point to draw from this is that, as
Canadian content regime for broadcast media by individuals are given more powerful tools and
the Internet provides an example of this sort of more options, regulatory frameworks designed
challenge. Previously, the Government of Canada to govern behaviours by coercively erecting
was able to foster the production of Canadian barriers to block individuals and enterprises from
cultural content by mandating that a percentage doing certain things will tend to be weakened.
of broadcast content met certain criteria for By enabling streaming services, for instance, the
Canadian-ness, such as the MAPL system for Internet has enabled many Canadians to opt out
defining a Canadian song.123 The Canadian of the highly regulated Canadian broadcasting
government was able to enforce this requirement industry, thereby undermining the ability of the
because the Canadian Radio-television and negative Canadian content regulatory framework
telecommunications Commission (CRTC), that governs it to achieve its goal of ensuring the
the industry’s regulator, was able to monitor production of Canadian content.
broadcasts and, if a broadcaster did not adhere to
the policy, take corrective action such as fines or A parallel situation is playing out in the rush of
the revocation of licenses. The logic of this policy investors keen to participate in unregulated ICOs
was that by guaranteeing a market for Canadian based in foreign countries. Canadian securities
54 | INSIDE THE BLACK BLOCKS

content, the government was guaranteeing that regulators are now facing a similar challenge
Canadian content would be produced. as the CRTC. Previously, these regulators relied
to a large extent on their ability to control
what offerings were allowed to trade on stock
123 Canadian Radio-television and Telecommunications
Commission. 10 August, 2009. “The MAPL system - defining exchanges to achieve their regulatory objectives.
a Canadian song.” Content Made by Canadians. Government of Now, this negative approach is being undermined.
Canada. https://crtc.gc.ca/eng/info_sht/r1.htm.
In such situations, governments are faced with achieve their goals more effectively. By offering or
two options. First, they can double down on enabling the thing for which there is demand, but
the negative approach and seek to improve doing so in a way that also allows the government
its functioning by extending its rules, making to integrate safeguards or steer the activity in
punishments more serious and increasing the its preferred direction, it may be better able to
resources devoted to enforcement. In many achieve its ultimate objective through inducement
cases, such an approach is unlikely to work rather than enforcement.
well in a society like Canada that cherishes
its liberties. Limiting access to the Internet, Novel legal questions
for example, would likely be decried as an
authoritarian outrage. As novel as many of these challenges are, they
are at least recognizable to most policymakers.
The other option is to use a proactive “positive” With Canadian content, for instance, governments
approach where, instead of seeking to block have long pursued a dual-track approach that
unwanted activities, governments take steps to mixes both negative and positive tools. Using
encourage desired ones. In the case of Canadian more positive tools in response to the arrival
content, such an approach would achieve the of streaming services represents a shift in
policy’s objective – namely, the creation of emphasis, not a new departure.
Canadian content – by proactively supporting
the creation of Canadian content by, for example, Conversely, some of the most important
providing funding directly to creators. challenges posed by blockchains will be the
novel legal questions for which there are no
In a blockchain context, such an approach real precedents. Or, as one author put it: “You
might see the Bank of Canada responding to the think it’s hard to figure out what Bitcoin is
popularity of cryptocurrencies by creating its from a regulatory standpoint, well, now we’re
own cryptocurrency. Similarly, the Government talking about figuring out what an autonomous
of Canada might respond to concerns about corporation is... [that’s] like something from The
corporate (mis)uses of individuals’ data by Matrix.”125
creating its own blockchain-based digital
identity as a foundation for a better digital Because of how they would remove the need
rights management framework.124 While these for employees, officers and directors – and
options are presented here as illustrations and even potentially owners – DAOs and DACs (see
not recommendations the key underlying point Box 7; hereafter, we use DAO to include both)
is critical, namely that by acting proactively, essentially reduce corporations to their legal
governments and regulators can potentially skeleton, namely a set objectives, some business
logic and agreements designed to achieve these
124 The United Kingdom (UK), for example, has taken steps in objectives. When this is all encoded in software,
this direction. This program, called GOV.UK Verify, enables citizens
55 | THE MOWAT CENTRE

to prove their identity online through the use of one of a few it can become difficult to distinguish DAOs from
trusted private firms’ identity verification systems. Having done computer programs like video games. But, unlike
this, citizens can then use this verified digital identity to access
government services, such as tax filing or checking the information
on their driver’s license. Government Digital Service. 12 July,
2018. Guidance GOV.UK Verify. Government of the United Kingdom.
https://www.gov.uk/government/publications/introducing-govuk- 125 Quoted in Vigna, P. and Casey, M. 2016. The Age of
verify/introducing-govuk-verify. Cryptocurrency. pg. 241.
 current video games, DAOs could
BOX 7
be completely decentralized, exist
Distributed Autonomous entirely on a blockchain, have no

Organization (DAO) or national domicile but still be able

to act in the physical world. This
Corporation (DAC) is because control over digitally
native assets could enable them
Traditional organizations or corporations to purchase services or exercise
consist of a Board of Directors that employs control over Internet-connected
managers and other employees to pursue a devices like autonomous
specific mission according to a set of by-laws vehicles.127 Should such creations
and within a business environment structured be allowed? If yes, how should
by laws, regulations and jurisprudence. they be regulated? How could such
The Board is accountable to members or regulations be enforced? If not,
shareholders for how well the corporation how could one country stop them
meets its goals which are usually set out in a from acting within their borders?
mission statement – supplemented by legal
and regulatory frameworks which further DAOs are only one of the more
define its duties. extreme potential applications
of the much wider concept of
A distributed autonomous organization
(DAO) or corporation (DAC) is an entity that smart contracts. Smart contracts
would replace the functions performed are an innovation separate from
by the corporation’s by-laws, mission blockchain but, because of
statement and employees – and potentially how blockchain enables their
the Board – with a set of smart contracts more widespread and powerful
that could control capital in a digitally native deployment, they helpfully
value system, collect information from pre- highlight the importance of
specified sources via the Internet, analyze approaching these interconnected
this information using machine learning technological innovations
algorithms. On the basis of this analysis holistically. In fact, blockchain-
the DAO/DAC would take actions, such as based smart contracts are
making investments, designed to advance
already beginning to appear:
its objectives within the applicable legal and
French insurer AXA recently
regulatory frameworks. While functionally
tested an automated Ethereum-
equivalent to a traditional corporation, the
enabled smart-contract-powered
current legal status of such, still largely
56 | INSIDE THE BLACK BLOCKS

theoretical, entities is unclear.126

127 Some thinkers have already suggested
that such vehicles, legally owned by not-for-
126 Malta has recently adopted a legal framework recognizing profit DAOs and directed by powerful machine
DAOs/DACs (which it refers to as “technological arrangements”) learning algorithms, could be created and
as similar to a traditional limited company with many of the mandated to provide inexpensive mobility
same rights and duties. See Ronstedt, M. and Eggert, A. 4 July, to marginalized communities. Kelion, L. 16
2018. “Among Blockchain-Friendly Jurisdictions, Malta Stands February, 2015. “Could driverless cars own
Out.” Coindesk. https://www.coindesk.com/among-blockchain- themselves?” News. BBC. http://www.bbc.com/
friendly-jurisdictions-malta-stands-out/. news/technology-30998361.
flight insurance policy that paid customers of algorithms to determine everything from who
automatically if their flight was more than two gets a job interview or a car loan to the length of
hours late. 128
a convict’s sentence.130 We raise these questions
not out of alarmism: the posing of novel legal
Smart contracts raise a number of important
puzzles is a necessary corollary of the emergence
questions. Currently, the control of courts and
of any new area or form of human activity. But
quasi-judicial agencies by humans like judges
it will take some time for courts, regulators and
enables human discretion and common sense
legislators to figure out the optimal governance
to intervene in the performance of a contract
frameworks for these areas. In order to minimize
if necessary, such as when extenuating or
the harm that is caused during this period of
mitigating circumstances arise. If a contract
transition, governments and regulators need to be
is self-executing and hosted on a blockchain,
thinking ahead, aggressively developing their own
however, it may be the case that nothing can be
capacity, consulting with stakeholders, educating
done to stop automatic performance of the contract
the public and actively piloting potential
– even if the results end up being monstrous,
responses.
unintended or in conflict with other laws.129 For
example, any contract agreed to under duress
would be a candidate for nullification by a court Governance
of law. But, if uploaded as a smart contract for We described earlier how blockchains may
performance on a domicile-less global blockchain, create competition for states in the market for
such nullification may not be possible even if governance services. While this certainly raises
backed by a court order. the question of how governments might compete
Similarly, sometimes monetary compensation for with these new providers, it also raises the
breach of contract may be a preferable alternative question of how these providers and services
to performance by one of the parties. While it ought to be governed.
may be possible to ensure options like this are
The infamous hack of “The DAO” in 2016 provides
written into smart contracts, it may be necessary
a helpful example of some of the issues that
to legally require inclusion of “escape clauses”
governments will need to think about in respect
of this type for them to actually be included
of blockchain governance.131 In this case,
given that increasing automaticity would likely
hackers exploited a flaw in the smart contracts
represents one of the key motivations for using a
that comprised “The DAO” – an autonomous
smart contract.
corporation that had been built on top of the
Other emerging challenges that blockchains Ethereum blockchain – and “tricked” it into
could sharpen – especially when they intersect transferring around $55 million (USD) worth of
with issues like automatic performance – include
questions of transparency and equity in the use
57 | THE MOWAT CENTRE

128 Higgins, S. 13 September, 2017. “AXA Is Using Ethereum’s 130 See O’Neil, C. 2017. Weapons of Math Destruction: How Big Data
Blockchain for a New Flight Insurance Product.” Coindesk. https:// Increases Inequality and Threatens Democracy. New York: Broadway
www.coindesk.com/axa-using-ethereums-blockchain-new-flight- Books.
insurance-product/. 131 Note, in this case “The DAO” refers to a specific decentralized
129 The authors thank Katie Szilagyi for bringing this issue to our autonomous corporation that was generically, and confusingly,
attention. named “The DAO”.
 ether to an account they controlled.132 It’s likely that the hard fork was essentially analogous to
that no laws were broken by the hackers because a mob-mandated retroactive changing of the law
the creators of “The DAO” had specifically stated that constituted a theft of $55 million from the
that the software that comprised “The DAO” was hackers who had done nothing wrong beyond
itself the authoritative version of the contracts reading “The DAO’s” fine print more carefully than
between the corporation and the investors and everyone else.134 This small minority argued that
that any other information about the corporation, doing so betrayed the entire idea of censorship
its purposes and its operations were superseded resistance and decided to continue using the
by the logic encoded in this software. According old version of the Ethereum blockchain, which
to this interpretation, anything the software was came to be called Ethereum Classic, on which the
capable of doing would be, by definition, in line hackers were still in possession of the “stolen”
with the contracts that governed “The DAO” and funds.
thus legal.
This controversy largely turns on the idea that the
Nevertheless, investors in “The DAO” who lost entire point of an autonomous organization like
money were understandably upset. Moreover, the “The DAO” is to remove arbitrary human decision-
Ethereum community was very concerned that, making and recognize that “code is law.”135
despite the fact that the Ethereum platform itself Indeed, because code was meant to be law, the
had not been compromised and was not at fault, need to hard fork the Ethereum blockchain was
this incident would cause irreparable harm to the unexpected and the entire procedure by which
larger Ethereum project simply by association. the decision was made was created on the fly
The Ethereum community eventually decided to without any pre-existing agreed-upon governance
“hard fork” the underlying Ethereum blockchain or decision-making processes.
at a point prior to the hackers’ transfer of the
Ethereum is not alone in having faced such
contested funds to allow the former owners of the
problems. Bitcoin has also experienced a number
ether in question to recover it.133
disagreements – largely concerning whether
This decision created a major controversy and block size should be increased – which have led
resulted in a split of the Ethereum blockchain into to hard forks that have created alternate versions
two distinct blockchains. Most miners and users of the currency such as Bitcoin Cash and Bitcoin
agreed to move forward with the hard fork and Gold. While less acute than “The DAO” incident,
the new version of Ethereum. A small minority of these conflicts also exposed a lack of governance
miners and users balked, however, and suggested infrastructure in the Bitcoin community – at least
as governance is traditionally understood.136
132 The Economist. 25 June, 2016. “Theft is property.” The
Economist. https://www.economist.com/news/finance-and-
economics/21701136-cyber-attacker-outsmarts-smart-contract-
58 | INSIDE THE BLACK BLOCKS

theft-property.
133 The “hard fork” described here is similar to the fork described 134 Schumpeter. 28 June, 2016. “Not-so-clever contracts.”
in Section 3 except that in addition to going back in time on The Economist. https://www.economist.com/news/
the blockchain and forking it at an earlier point in the record of business/21702758-time-being-least-human-judgment-still-better-
transactions, this fork also involved simultaneously changing the bet-cold-hearted.
underlying software that operated the blockchain. These sorts of 135 Lessig, L. 1 January, 2000. “Code Is Law: On Liberty in
changes to the blockchain’s operating software are called either Cyberspace.” Harvard Magazine. https://harvardmagazine.
“soft forks” – which refer to changes that maintain backwards com/2000/01/code-is-law-html.
compatibility with previous versions of the software – and “hard 136 An account of Bitcoin’s “Civil War” can be found in Casey, M.
forks” which do not. and Vigna, P. 2018. The Truth Machine. Pages 71-79.
Ultimately, all these controversies were resolved Moreover, even if they end up ceding the
by having the users and miners decide for market for some “governance services” to new
themselves which versions of these blockchains competitors, governments will not be able to
they wanted to continue using. At one level this wash their hands of the need to ensure that
is actually quite democratic – no one is forcing these services are delivered to their citizens in
anyone to use any of these blockchains. But ways that adhere to constitutional requirements
this emerging “vote with your feet” approach or obligations under international treaties. For
to governance – which one can also discern in a variety of reasons, not everyone has the same
e-residency’s limited empowering of individuals to ability to walk away and governments have a
shop around for the government they like best – responsibility to ensure that these individuals are
is a novel way to govern a community, at least in not inequitably disadvantaged, regardless of what
a context where digital tools make it much easier others do.
to implement than previously. While this might be
exciting to some, especially libertarians, it’s pretty The questions raised by this incipient “vote with
clear that governments are only just beginning your feet” approach to governance represent
to think through the potential implications of the only a sub-set of a host of questions that could
spread of this approach. be raised by the emergence of blockchain and to
which governments will need to respond. How for
In fact, as blockchains continue to grow in size, instance might the “right to erasure” guaranteed
importance, and ubiquity, governments may find by the EU’s General Data Protection Regulation
that the use of a “vote with your feet” approach (GDPR) be given effect on an immutable public
is not desirable in all cases of conflict with the blockchain? How should governments reach
results of their own decision-making procedures accommodations with the private networks
and political processes. Situations may arise that operate blockchains – or conceivably
where they find they have a much stronger with non-human DAOs? Alternatively, how
desire or need to become involved in blockchain might governments stop DAOs offering illegal
governance. For instance, how large a proportion services via blockchain if these decentralized,
of a country’s economic activity will need to be distributed entities have no national domicile?
conducted using Bitcoin before that country While the answers to these questions remain
decides it needs to find some way to exercise to be determined, one thing that is clear is that
some control over the currency? If code is law, governments need to not only begin thinking
then those who are impacted by the code will about them, but to also start actively working to
eventually – and reasonably – want there to be shape the decisions that will need to be taken.
a fair, predictable, transparent and democratic This will involve working to influence when these
procedure for how that code can be changed questions make it onto the agenda and the fora in
short of walking away from it. which decisions about them are taken.
59 | THE MOWAT CENTRE
 While blindly copying
other jurisdictions is
likely not the answer,
changing the negative
perception held by
many blockchain
innovators and
entrepreneurs
ought to be a
priority for Canada’s
governments and
60 | INSIDE THE BLACK BLOCKS

regulators.
6 RECOMMENDATIONS
Developments in the blockchain community are moving very quickly. When we approached one
blockchain entrepreneur for an interview, his response was to ask: “Why are you doing research so late
in the game when there are lots of others that have done extensive research?” It was almost as if he
was saying that if you are not already up to speed on blockchain, you might as well not even try to catch up.

If this report represents your first thorough

engagement with blockchain, this type of response Build internal capacity
can be deflating and concerning. But, while it is Given that blockchain is such a new development,
true that government has some catching up to do, it should not be surprising that the level of
we suggest taking this quotation as we took it: as blockchain expertise and capacity within Canadian
a reminder that events are moving fast and a spur governments and regulators is currently limited.137
to get a move on, certainly, but also as a reminder One of the first steps that governments need to
of the need to be wary of some of the exuberance, take in preparing for the impacts of blockchain
skewed perspectives and self-promotion that is to increase their own internal capacity. In the
pervade the industry. first instance, this means building up groups
In this final substantive section, we offer the of technologists and policymakers within
following five recommendations to policymakers: government who understand the technology, its
implications and the potential opportunities and
»» Build internal capacity challenges that flow from it.
»» Create an attractive environment for blockchain
It is encouraging that Canadian governments are
innovation
alive to this challenge and the need to increase
»» Support internal and allied experimentation their internal capacity. Indeed, many have already
taken some important initial steps:
»» Make use of standards and other flexible tools
»» Innovation, Science and Economic Development
»» Foster national and global governance
Canada has been involved as a partner in
cooperation
61 | THE MOWAT CENTRE

blockchain proofs of concept and pilot projects

Implementing these recommendations will help with a number of provincial and municipal
governments capture the potential benefits government partners.
offered by blockchain and avoid its pitfalls.
137 Stein, S. 14 February, 2018. “Blockchain engineers are in
demand.” TechCrunch. https://techcrunch.com/2018/02/14/
blockchain-engineers-are-in-demand/.
 »» Treasury Board Secretariat recently hosted a the use of DLT for improving the security
Government of Canada Blockchain Codefest settlements process.139
and a Blockchain Day conference to advance
These are all positive steps but they will need
the federal government’s understanding of the
to continue and multiply. As we have previously
technology.
recommended in the context of the relationship
»» The National Research Council of Canada between government and disruptive technologies,
has experimented with using the Ethereum proofs of concept and pilot projects140 – really
blockchain as a way of executing and posting any initiative that provides hands-on experience
grant and contribution agreements which it – are critically important to building capacity.
already discloses publicly. Additionally, governments should pursue:

»» As discussed in section 5, the Government of »» Greater encouragement of secondments and

Ontario and the City of Toronto ran a proof of interchanges with external blockchain and DLT
concept designed to investigate potential uses firms and organizations by government staff.
of blockchain technology in increasing the
ease of use and efficiency for the restaurant »» Fellowships and other programs designed to
permitting process. The Government of Ontario attract academics with blockchain expertise to
also recently ran a blockchain hackathon work in the government for a set period of time.
that generated a number of ideas for other »» Specific, carefully designed and well-supported
blockchain applications in government. programs for private sector technologists to do
»» As noted in section 5, the Government of a “tour of duty” in government for a set period of
British Columbia will soon be launching its time or for a specific blockchain or DLT project.
Verified Organization Network (VON) with »» Greater encouragement of, and support for,
the aim of putting government permits and existing government employees to pursue
other “verifiable claims” on a blockchain and, educational leaves to upgrade their blockchain
eventually, enabling individuals and businesses and DLT knowledge and skills.
to use their own digital wallets to prove their
»» Better integration of new learning opportunities
credentials to third parties.
like micro-credentials and nano-degrees
»» Project Jasper is a joint initiative between the targeted at enhancing government employees’
Bank of Canada and a variety of other financial capacity in blockchain and DLT.
institutions and actors. Jasper’s first and
Critically, these recommendations need to
second stages involved the building and testing
go beyond simply building internal technical
of a “CADcoin,” a DLT-based interbank payments
capacity. While some technical capacity will be
settlement instrument.138 Jasper’s third stage,
essential for governments to be able to identify,
on which the Bank of Canada is partnering with
62 | INSIDE THE BLACK BLOCKS

procure, implement and manage blockchain

Payments Canada and Toronto Stock Exchange
operator TMX Group Ltd, is focused on testing
139 Reuters Staff. 17 October, 2017. “Bank of Canada, TMX to test
blockchain for securities settlement.” Reuters. https://www.reuters.
138 Wilkins, C. 19 May, 2017. “Project Jasper: Lessons From com/article/us-boc-tmx-grp-blockchain/bank-of-canada-tmx-to-
Bank of Canada’s First Blockchain Project.” Coindesk. https://www. test-blockchain-for-securities-settlement-idUSKBN1CM30X.
coindesk.com/project-jasper-lessons-bank-of-canada-blockchain- 140 Johal, S. and Urban, M. 11, May, 2017. Regulating Disruption.
project/. Pages 28-29.
and DLT use cases in the public sector, many of Building a strong understanding of the non-
the most important challenges this technology technical aspects of the technology will,
creates lie in its implications for policy, regulation ultimately, be even more important for managing
and the law. Not only does government need not just how government itself uses blockchain,
to upgrade its technical capacity, it needs to but also how it modifies its policy, regulatory
build familiarity and upgrade its understanding and legal frameworks to address the challenges
of the technology’s non-technical implications and seize the opportunities that the technology
throughout government and society. presents for society at large. Moreover, it is
precisely these sorts of individuals who will be
Given that governments exist in an environment critical to the successful implementation of many
of fiscal restraint, building up the capacity of of our additional recommendations.
those parts of government that will grapple with
the challenges and opportunities associated with Finally, one of this report’s reviewers suggested
blockchain’s emergence should be prioritized. that even before an organization starts to
This list ought to include regulators that are build capacity, it is critical to ask “do we
already confronting these new developments actually have a use case’ for blockchain? Is
such as securities commissions, as well as those blockchain relevant to our work in a way that
entities that have the most obvious immediate offers substantially superior results compared
uses for the technology such as shared and to existing approaches?” These are critical
government services agencies. questions to ask and it is true that not every
government department or agency will require
Given their central role supporting other in-house blockchain capacity. Awkwardly, being
departments, central agencies should also able to answer these questions itself requires
be a focus for capacity building, especially a significant level of blockchain expertise. This
on the policy side. Existing policy innovation underlines the importance of government as
organs, such as Ontario’s Policy Innovation Hub, a whole, and central agencies in particular,
could even be directed to develop an internal developing nimble and re-deployable capacity
government consultancy function to support able to facilitate the sorts of analyses which
other parts of government. Finally, ensuring that individual departments and agencies that cannot
senior executives understand blockchain at a (yet?) justify their own build-up of capacity will
sufficient level so that they are able to effectively need.
integrate blockchain and DLT-related policy advice
into their decision-making will also be critical. 63 | THE MOWAT CENTRE
 to locate there. Not only do many local stores
Create an attractive accept payment in bitcoin, but so too does the
environment for local government for many taxes and fees. Given
this approach, it is not surprising that four out of
blockchain innovation 2017’s ten biggest ICOs were based in Zug – a
Even with a commitment to increasing town of just under 30,000 people.145
internal capacity, it is unrealistic to expect
Other jurisdictions are also staking claims to
that government will be able to compete with
being one of the world’s blockchain hubs. For
the private sector for the best and brightest
example, the US state of Delaware, seeking to
blockchain innovators.141 But, given the relative
build on its existing dominance in corporate
strength of Canada’s homegrown blockchain
formation and the expertise of its business
talent,142 Canadian governments have a good
courts, was the first jurisdiction in the world to
opportunity to build and support an innovative
explicitly allow corporations to maintain their
blockchain ecosystem in Canada. By doing so,
corporate shares using a blockchain-based
and by building strong relationships with this
ledger.146 It is also looking at enabling the creation
sector, governments should be able to leverage
and maintenance of certain legal documents that
this sector and its expertise in many of the ways
often interact with shares on this blockchain and
described above. Successfully building and
to enable shareholder voting through blockchain
maintaining this sector, however, will depend on
technology.147
governments’ abilities to create an environment
capable of attracting blockchain entrepreneurs Encouragingly, Canadian governments and
and innovators and retaining them. 143 regulators are trying to move in this direction. For
instance, the Canadian Securities Administrators
Some other jurisdictions have already taken
(CSA) – an umbrella organization for Canada’s
significant steps in this direction.144 The town of
provincial and territorial securities regulators –
Zug in Switzerland has, for example, been dubbed
has produced a number of staff notices to provide
“Crypto Valley” for its government’s enthusiasm
entrepreneurs and firms with insight into the
for encouraging blockchain and related firms
evolution of regulators’ views. In its most recent
notice, it even recognized the possibility of there
141 Indeed, demand “is off the charts” with “14 job openings for
every one blockchain developer.” See Stein, S. 14 February, 2018. being a difference between a utility token and a
“Blockchain engineers are in demand.”
security token – a significant regulatory step.148
142 Canada was ranked third in terms of the number of blockchain
start-ups behind the USA and the UK with the Toronto area
accounting for much of this activity. Blatchford, A. 28 February, 145 The Economist. 24 February, 2018. “A banking centre seeks
2017. “Ottawa explores potential of ‘blockchain,’ billed as next- to reinvent itself.” The Economist. https://www.economist.com/
generation Internet tech.” The Toronto Star. https://www.thestar. finance-and-economics/2018/02/24/a-banking-centre-seeks-to-
com/business/2017/02/28/ottawa-explores-potential-of- reinvent-itself.
64 | INSIDE THE BLACK BLOCKS

blockchain-billed-as-next-generation-internet-tech.html. 146 Adlerstein, D. and Tinianow, A. 21 April, 2018. “Why ICOs Could
143 In this light, the failure of the proposed blockchain Eat Delaware’s Lunch.”
supercluster application to even make the shortlist in the federal 147 Stromberg, T. Negre, J. Reinhardt, M. Peleg, M. 23 March,
government’s supercluster selection process represents a 2018. “Are Headwinds Hampering Delaware’s Blockchain
missed opportunity. See https://www.canada.ca/en/innovation- Initiative?” Law360. https://jenner.com/system/assets/
science-economic-development/news/2017/10/innovation_ publications/17844/original/stromberg%20Law360%20March%20
superclustersinitiativeshortlistofapplicants.html. 23%202018.pdf?1521837416.
144 Popper, N. 29 July, 2018. “Have a Cryptocurrency 148 Canadian Securities Administrators. 11 June, 2018. “Securities
Company? Bermuda, Malta or Gibraltar Wants You.” The New Law Implications for Offerings of Tokens.” CSA Staff Notice 46-308.
York Times. https://www.nytimes.com/2018/07/29/technology/ http://www.osc.gov.on.ca/en/SecuritiesLaw_csa_20180611_46-
cryptocurrency-bermuda-malta-gibraltar.html. 308_securities-law-implications-for-offerings-of-tokens.htm.
The CSA’s regulatory sandbox (see Box 8),149 is
BOX 8
another good example of regulators seeking to
be flexible and meet the needs of blockchain Regulatory
innovators.
Sandbox
Despite these laudable efforts, Canada is not
currently seen as a leader in the regulation of A program operated by a
digital assets. Many of our interviewees who are regulator which provides
active in the blockchain sector suggested that enrolled firms temporary
their interactions with Canadian governments exemptive relief from
and regulators had not been particularly certain regulatory or legal
encouraging. Some complained of delays and requirements. The relief
unresponsiveness from regulators as well as offered to firms is usually
unclear guidance. One even suggested that by the delimited in scope – up
to a certain number of
time that this report was published, there was a
transactions or customers –
good possibility that they would have moved to
or in duration. The purpose
another, more supportive, jurisdiction.150 Another
of a regulatory sandbox is to
declared bluntly that “the brain drain is real” and
enable successful applicants
that Canada has lost many of the advantages that
to test new and potentially
it enjoyed in blockchain even just a few years ago. innovative and beneficial
Unfortunately, even though the regulatory products and services
challenges posed by blockchain are not unique whose development might
otherwise be discouraged
to Canada, the regulatory uncertainty that has
by existing regulatory or
persisted here has eroded some of Canada’s
legal frameworks. Ideally,
attractiveness among entrepreneurs. While
this relaxed regulatory
blindly copying other jurisdictions is likely not the
environment will be coupled
answer, changing the negative perception held by with tailored and ongoing
many blockchain innovators and entrepreneurs engagement by the regulator
ought to be a priority for Canada’s governments with successful applicants
and regulators.151 as a means of facilitating
innovation, protecting
consumers and enabling
regulators to learn about new
149 See https://www.securities-administrators.ca/industry_ innovations and potential
resources.aspx?id=1588.
150 See also The Economist. 24 February, 2018. “A banking centre
regulatory changes they
seeks to reinvent itself.” should consider.
151 To be fair, Canadian regulators’ responses to blockchain
65 | THE MOWAT CENTRE

innovations are in line with Canada’s generally prudential approach

to financial regulation, an approach that was much lauded during
the most recent global financial crises. It may also be the case
that some jurisdictions with more lax approaches are actually
engaging in a “race to the bottom” and reducing their regulations
imprudently. Thus, Canadian regulation of digital assets also likely
represents, at least partially, a conscious decision to proceed
with caution, even if it means losing out on some homegrown
blockchain innovation.
 One way to build a more attractive environment still achieving the underlying objectives of the
for innovation is to get more creative. One regulatory framework, namely to determine the
interviewee suggested that one particularly useful level of the investor’s sophistication.
way of doing this would be to try and find ways of
aligning regulatory requirements for innovators This idea is not offered as a specific
with the way that the “crypto community” itself recommendation, but as an illustration of the
thinks about blockchain while still ensuring that sort of creative thinking being advocated. One
the principles behind these regulatory regimes way to identify creative ideas like this would be
were being applied. To see how this might be to increase efforts to build a strong network of
accomplished, consider the following example. relationships between policymakers, regulators
and entrepreneurs and technologists. Some
Many financial institutions have a set of of the capacity building tools identified earlier,
regulatory responsibilities collectively called specifically those that encourage exchanges
“know your customer” (KYC). Depending on the of personnel like the successful Presidential
product or service being offered, one part of KYC Innovation Fellows program in the US,152 could
is a requirement for the institution to take steps to go a long way to building these relationships
understand an investor’s strategies, expectations and a culture of innovation within government.
and level of sophistication and to then tailor their While governments and regulators will often
offerings to this customer accordingly. Currently, have different priorities and responsibilities
such “client-onboarding” can take significant than entrepreneurs and should thus be wary
time and involve questionnaires, the submission of regulatory capture, it is exactly these sorts
of documentation and numerous other due of exchanges which could boost Canada’s
diligence activities. Our interviewee suggested regulatory innovation and attractiveness.153 Such
that a creative way for blockchain firms to fulfil insight will be especially important in the case
some of their KYC requirements around investor of blockchain, given the many novel regulatory
sophistication might be to allow firms to use challenges the technology will create.
technical indicators to provide this information,
an approach that aligns with a lot of current Another positive step that could be taken would
thinking in the crypto community. be to create standing advisory committees
designed to bring industry, consumer, and
For instance, if a buyer wanted to use a community members with a stake in specific
cryptocurrency to purchase another crypto-asset, potential blockchain implementations into
as opposed to a fiat currency-denominated credit contact with policymakers working in the space.
card, this would be taken to indicate a higher These committees could offer technical advice,
than average level of investor sophistication. The sector intelligence and serve as conduits to
use by a buyer of a personal crypto-wallet in this additional expertise, as well as offering an
66 | INSIDE THE BLACK BLOCKS

transaction instead of an account at a crypto- important challenge function for proposed

exchange would be taken to indicate an even
higher level of sophistication. The motivation 152 Ehlinger, S. 9 January, 2017. “Effort to codify Presidential
for using such an approach as a part of KYC Innovation Fellows program is back in House.” Statescoop. https://
statescoop.com/effort-to-codify-presidential-innovation-fellows-
due diligence would be that it could reduce the program-is-back-in-house.
regulatory burden on firms and customers, while 153 Johal, S. and Urban, M. 11, May, 2017. Regulating Disruption.
Pages 18-19.
government blockchain applications or policies. By piloting, governments could respond to
Increased self-organization within the blockchain complaints like this and begin to build the
industry could also help to provide government expertise and trust they need to move on to
with a more robust interlocutor. larger partnerships in the future. Such an
approach would also help to advance Canadian
Support internal and governments’ oft-stated desires to nurture
homegrown technology start-ups and help
allied experimentation these companies scale up their operations while
As was highlighted earlier, one effective way for remaining in Canada.
governments and regulators to build improved
Finally, it is important that governments do not
internal capacity and better relationships with
attempt to develop large blockchain solutions
stakeholders is to actively support the piloting of
aimed at replacing numerous legacy systems
potential use cases of blockchain and DLT in the
in a single “Big Bang.” As demonstrated by
broader public sector.
repeated failures, delivering massive information
Supporting pilots might be especially productive technology systems of this type rarely works well
at a local level or in partnership with a small set or stays on budget. Nimble approaches that start
of connected institutions such as a hospital and with small scale tests and are designed to grow
a network of medical clinics. By starting small, iteratively in ways that gradually integrate with
governments limit risk and enable themselves procurement schedules and lifecycles of existing
to develop internal expertise before the stakes systems are more likely to succeed. One of the
become very high. Moreover, by starting local characteristics of blockchain and DLT that make
but working collaboratively, these projects can them particularly suitable to such an approach
help spread risk between the partners. This is is how they can be designed to connect to and
important as some of the best candidates for coordinate other systems and expand organically
the sorts of low-risk implementations ideal for over time, thereby avoiding the need for risky and
piloting lie with municipal governments that highly complicated system-wide overhauls.
might otherwise lack the funds or expertise
needed. Federal and provincial governments
would benefit from providing funds and expertise
by gaining the opportunity to learn with only low
levels of risk.

These sorts of projects would also enable

multiple levels of government to connect with
and gain experience collaborating with private
sector firms and entrepreneurs. One of the
67 | THE MOWAT CENTRE

complaints most often heard from technology

entrepreneurs in Canada is that they lack large
institutional reference customers like government
– something they argue disadvantages them
as they work to scale up their businesses.
 of accreditation could even be hosted on a public
Make greater use of blockchain maintained by regulators.
standards and other Standards might not be as effective as negative
flexible tools regulatory tools were in earlier times, but they
would likely be much better than the current
As was discussed in Section 4, blockchain will
situation in which securities regulators’ ability
likely entail a reduction in the effectiveness
to respond effectively to ICOs has been greatly
of negative regulatory approaches and the
impaired. Ideally standards could be developed
emergence of several novel legal questions. For
in cooperation with organizations like the CSA
governments and regulators looking to protect
and OSC. This is important because the reality is
the public interest in this changing environment,
that there is a growing appetite for ICOs and there
this will likely mean some shifts in emphasis and
is little that regulators will be able to do to stop
the adoption of some new tools.
motivated individuals from participating in this
One good example of a context in which new market. By reconsidering their approach instead
tools are needed is ICOs. While many ICOs of sitting on the sidelines, regulators would be
are helping innovators get their ideas off the able to offer some form of protection where
ground, some are clearly frauds.154 Ostensibly, otherwise there would be none. While this may
there are regulatory bodies such as the Ontario not be an ideal solution, it could at least help to
Securities Commission (OSC) that are mandated rein in some of the excesses of the sector.
to protect investors from these sorts of scams.
In addition to providing a helpful regulatory tool,
But, given that many ICOs are both accessible
standards will also be essential in ensuring that
via the Internet and based in other jurisdictions
blockchain is able to reach its full potential in
to which the OSC’s authority does not extend,
terms of impact. For instance, given some of
it is essentially impossible for the OSC to use
the challenges around the scalability of public,
its traditional negative tools, such as fines or
permissionless blockchains, it is likely that
blocking the listing of a security on an exchange,
there will be many, many blockchains operating
to protect investors.
in the future. In this context, blockchains
The development of standards represents an will need to be compatible and interoperable
alternative, positive approach worth exploring in order to maximize their usefulness. One
in this regard. The idea would be to create and need look no further than the example of how
publicize a standard that included a set of common protocols like TCP/IP were critical
requirements around disclosure and reporting to unlocking the Internet’s potential in order
that firms undertaking ICOs would need to to see the importance of interoperability. By
allowing different blockchains to integrate easily
68 | INSIDE THE BLACK BLOCKS

meet in order to have their offering receive

accreditation.155 A list of ICOs achieving this level with each other and enabling crypto assets to
move between blockchains, the development
154 Matsakis, L. 30 January, 2018. “Cryptocurrency Scams Are of widely accepted crypto-standards could play
Just Straight-up Trolling at this Point.” Wired. https://www.wired. a significant role in unlocking blockchain’s full
com/story/cryptocurrency-scams-ico-trolling/.
155 In the UK, the TrustSeal standard has been developed along potential.
similar lines for accrediting firms offering sharing economy
services. See https://sharingeconomytrustseal.com/about/.
One example of how this is already occurring Whatever standards are adopted, enforcement
can be found in the creation of the ERC-20 token might require inventiveness. For instance,
standard developed by the Ethereum Foundation regulators could consider working with
– the body that more-or-less administers the academics to create open source algorithms
Ethereum blockchain. The ERC-20 standard is the capable of scanning smart contracts for
most popular standard for start-ups conducting adherence to specific standards. Blockchains
an ICO. Given that the Ethereum Foundation that run smart contracts could also be explicitly
is a not-for-profit foundation that is generally programmed to block the performance of
perceived as playing a fairly benevolent role, there certain types of contractual terms.157 Whatever
has not been too much concern about it playing the specific form it took, the key feature of
a standard setting role so far. Regardless, as this approach would be to move away from
blockchains like Ethereum grow in importance, unenforceable prohibitions and towards proactive
governments will be forced to decide if they measures to provide individuals and firms with
are willing to allow very new organizations, tools they could use to protect themselves.
with unclear accountability structures and
essentially no democratic legitimacy, to make Foster national and
very consequential decisions with little-to-
no opportunities for national governments to global governance
influence how these decisions are made. cooperation
Farther along the line, governments will need to Blockchain is a global phenomenon and,
confront some of the more novel legal questions consequently, a significant proportion of any
that the development of a digitally native value successful attempt at governing it will necessarily
system and the emergence of smart contracts take place at the global level. Unfortunately,
entails. The creation of standards for smart the critical importance of improved national
contracts, or even open source model contracts, and international cooperation by governments
could be useful. Indeed, there are already and regulators is an area currently receiving
examples to draw on. In the USA, the Mortgage insufficient attention. More governmental
Industry Standards Maintenance Organization cooperation will be essential to overcoming some
(MISMO) has created a set of standards that of the most important challenges that blockchain
show how a specific form of legal contract can will create.
be standardized under the supervision of an
independent organization that is scrutinized With regard to blockchain Canada currently
by government or regulators to ensure respect faces three main challenges with international
for the public good.156 In this approach, there dimensions. The first one is familiar: jurisdictional
could be a requirement that any deviations from arbitrage. Jurisdictional arbitrage refers to how
the model contract would need to be explicitly individuals, networks and firms can leverage
69 | THE MOWAT CENTRE

signalled to the user and justified before the differences in jurisdictions’ regulations in ways
contract could be signed. that advantage them, often at the expense of at

157 This is arguably what occurred in “The DAO” debacle with

Ethereum, though the decision not to enforce the terms of the
156 See http://www.mismo.org/. contract was ad hoc and applied retroactively.
 least one jurisdiction.158 A common example is These challenges will grow in importance as an
for a firm to declare profits in one jurisdiction that increasing amount of financial activity moves
were actually generated in a second jurisdiction out of national currencies and onto blockchain
where a higher corporate tax rate was in effect. networks.162 While even perfect international
This is already encouraging a sub-optimal race cooperation is unlikely to stop blockchains from
to the bottom among jurisdictions as they being used for undesirable activities, individual
attempt to attract firms by enacting lower and countries will find it extremely difficult to take
lower tax rates and increasingly lax regulatory meaningful action against these activities
environments that end up sacrificing the wider because of their distributed, even ephemeral,
public interest. 159
There may already be a race character.163
to the bottom taking place to attract blockchain
firms, which is a problem in its own right. But, by The best hope governments have in this regard
making it easier to move value around digitally, is working together and presenting as united a
blockchains may also make it more difficult to front as possible. Thus, in addition to developing
combat jurisdictional arbitrage by firms in other methods for regulating activities “on-chain” as
sectors as well, worsening an already serious discussed in earlier subsections, governments
problem.160 will also need to improve their ability to cooperate
effectively “off-chain.”
Second, the decentralized and distributed
nature of blockchain makes it difficult for Third, just as the non-territorial nature of
governments to combat undesirable forms of blockchains makes it difficult to negatively
activity that use it, such as tax evasion or money enforce national laws, it also offers opportunities
laundering.161 It also makes it difficult to impose for powerful governments to try and impose their
requirements on blockchains that operate in preferred solutions extraterritorially across the
other jurisdictions – such as the idea mentioned entire network by leveraging their “off-chain”
earlier about disabling certain contractual terms. power. In other words, these governments may
seek to develop standards that advantage them
and use their power in the physical world to
158 For a more in-depth discussion see Johal, S. et al. 30 July,
impose or induce their acceptance globally. While
2017. Robots, Revenues & Responses. Pages 33-35.
159 The Organisation for Economic Cooperation and having uniform standards might be desirable
Development’s (OECD) Base Erosion and Profit Shifting (BEPS) task
in abstract, Canadian citizens are unlikely to
force estimates that these sorts of practices “cost countries 100-
240 billion USD in lost revenue annually, which is the equivalent to want to simply accept standards developed
4-10% of the global corporate income tax revenue.” G20 and OECD.
July 2018. Inclusive Framework on BEPS: A global answer to a global
and unilaterally imposed on them by others
issue. OECD. http://www.oecd.org/tax/flyer-inclusive-framework-on- without their input. To ensure that Canadian
beps.pdf.
160 A recent study found that “The average corporate tax
perspectives and interests are integrated into
rate globally has fallen by more than half over the past three
70 | INSIDE THE BLACK BLOCKS

decades, from 49 percent in 1985 to 24 percent in 2018.” Stein,

J. 24 July, 2018. “Across the globe, taxes on corporations 162 Johal, S. et al. 30 July, 2017. Robots, Revenues & Responses.
plummet.” The Washington Post. https://www.washingtonpost. Pages 40-41.
com/business/2018/07/24/across-globe-taxes-corporations- 163 A good example was the Spanish government’s inability to
plummet/?noredirect=on&utm_term=.1e9489353c71. disrupt the online aspects of the referendum in Catalonia because
161 The Economist. 26 April, 2018. “Crypto money-laundering.” of how the Catalan government used a decentralized protocol, the
The Economist. https://www.economist.com/finance-and- InterPlanetary File System (IPFS) to disseminate information about
economics/2018/04/26/crypto-money-laundering. The head of where and when to vote. Dedi, D. 23 October, 2017. “IPFS’s first win:
Europol estimates that already 3-4% of criminal revenues in Europe the Catalan referendum.” CryptoInsider. https://cryptoinsider.com/
is laundered through cryptocurrencies. content/ipfs-first-win-the-catalan-referendum/index.html.
the processes that produce these standards, standards for blockchain and DLT.166 From our
Canadian governments, firms and non- interviews, we understand, albeit from second-
governmental organizations need to be proactive hand sources, that Canada is participating in
in engaging other interested parties and working this exercise but that the Canadians involved are
constructively to fill the existing regulatory not receiving as much support as they ought to
vacuum. be. Moreover, other interviewees suggested the
ISO process may, ultimately, be of only marginal
While concrete international action on blockchain importance. They suggest that governments
is probably not yet warranted, countries like really need to get over their unwillingness to
Canada should already be engaging like-minded get involved in the standards development work
states in multilateral discussions on how to being done in “consortia” contexts – where small
collaboratively solve the problems that blockchain groups of private firms develop standards – and
will create. International organizations such as also begin to explore how they might interface
the UN, the G20 and others could play a larger with the governance discussions occurring
role in helping to create a consistent international around the most important public blockchains
framework that can help limit a regulatory race like Ethereum and Bitcoin.
to the bottom, keep these new technologies from
contributing to problems like tax-base erosion,
and ensure they contribute to the greater good.164
For example, the UN Commission on International
Trade Law (UNCITRAL) could potentially serve
as a good forum for the development and
dissemination of “model laws” that address these
problems or for preparing and building support
for an international convention on blockchain
governance.165

Additionally, Canada should ensure that its

interests and perspectives are represented in
any international exercises in standard setting.
An ISO technical committee (ISC/TC-307), led by
Standards Australia, is already working on ten

164 See, for instance, Maupin, J. March 2017. “Blockchains and

the G20: Building an Inclusive, Transparent and Accountable
Digital Economy.” Policy Brief No. 101. CIGI. https://www.
cigionline.org/sites/default/files/documents/PB%20no.101.pdf.
At the moment, the G20 has not yet taken any concrete steps:
Suberg, W. 23 July, 2018. “G20 Forum Shelves Deadline for ‘Very
71 | THE MOWAT CENTRE

Specific Recommendations’ on Crypto.” CoinTelegraph. https://

cointelegraph.com/news/g20-forum-shelves-deadline-for-very-
specific-recommendations-on-crypto.
165 Models laws are legislative drafts developed by legal experts
working for UNCITRAL and on the basis of the organization’s
consultations with UN member states. States are invited to use 166 These include standards on privacy, security, terminology,
these expertly-drafted model laws as the basis for national laws. identify management, and smart contracting. See https://www.iso.
See http://www.uncitral.org/uncitral/en/about_us.html. org/committee/6266604.html.
 Over the time that
this paper was
researched and
written, the price
of a single bitcoin
has gone from
about $1,200 to
over $25,000 and is
now back to about
72 | INSIDE THE BLACK BLOCKS

$10,500 (CAD).
7 CONCLUSION
As stated in the Introduction, this report is not designed to be a comprehensive discussion of
blockchain or its applications. What it does aim to do is to provide policymakers with a fundamental
understanding of the key concepts and the basic intellectual tools they will need to continue their
exploration of this new technology with greater confidence. Thus, we close this report by summarizing
the three key thematic takeaways from our research and by offering a gentle warning regarding the role
that is being played by hype in the blockchain sector.

Key Takeaways
Blockchain can be a complicated topic and with 2] Blockchains and distributed ledgers also offer
so much going on in terms of new ICOs launching, other less revolutionary, but still significant,
companies and governments announcing new ways of organizing and coordinating
proofs of concept, and enthusiasts offering information systems and tracking a variety
fantastical speculations, identifying what is of assets. These implementations will enable
important can be difficult. Our research has led greater efficiency and decentralization which
us to believe that there are three fundamental could help secure greater privacy and a more
conclusions that policymakers need to be aware even distribution of power in the digital era.
of and need to integrate into their thinking:
3] The most significant implications of blockchain
1] Blockchain marks the arrival of the first will arise from its interactions with other
digitally native value system. Blockchains emerging technologies. For many of the most
enable the creation of a digitally native value revolutionary impacts that commentators
system which in turn lays the foundation for often predict for blockchain, blockchain will
potentially revolutionary automation in new only be one of many contributing inputs. For
areas. By enabling software to more easily example, when commentators get excited by
manipulate value and by helping to make smart the possibility of blockchain-enhanced EHRs
contracting much easier, blockchains will enabling massive medical breakthroughs
73 | THE MOWAT CENTRE

enable software to do many new and important through vastly improved access to anonymized
things that it cannot do today. patient medical data,167 the key development

167 Swan, M. 2015. Blockchain: Blueprint for a New Economy.

Sebastopol, CA: O’Reilly. Page 62.
 that will enable this probably lies with the since fallen back to about $600.168 Other less
machine learning algorithms that will make well-known tokens have had even wilder rides
the discoveries just as much as with the and overall, the fall back to less inflated prices
blockchain technology which will organize the from the heights of speculation reached in early
information and facilitate access to it. This January 2018 wiped out an astounding $500
pattern will likely be the same across many of billion (USD) in value worldwide in about one
the possibilities described as being offered by month.169
blockchain. Thus, any effective government
response will need to be holistic. It is very important for policymakers not to get
distracted by this speculative rollercoaster.
Naturally, there are many other issues related Blockchain and DLT offer many benefits, as
to blockchain that will grow in importance in well as some real dangers, that are completely
the future but which are not covered by this unconnected to the rise and fall of the price of a
report. We hope that this report’s analysis of the bitcoin. At a deeper level, new technologies are
fundamental concepts and questions raised by often buffeted by inflated expectations based on
this new technology will leave readers better imperfect understandings, speculation and the
prepared to ask the right questions and to simple inability to predict the future that even
separate what is real from what is hype. the most visionary innovators cannot avoid. This
pattern has even been recognized and formalized
Blinded by the hype? as the “Hype Cycle” illustrated in Figure 17.

The question of hype is an important one to

consider as we close this paper. When we began FIGURE 17
our research project in early 2017, many had The Gartner hype cycle
already begun to see blockchain as something
Visibility
of yesterday’s news. At that time, AI and
Peak of Inflated Expectations
machine learning were the new hot topics that
everyone was talking about. Blockchain was
Plateau of Productivity
seen as increasingly passé and “so 2015.” But
then, in the final third of 2017, the price of a
variety of cryptocurrencies started to explode Slope of Enlightenment

and it seemed like everyone was talking about

blockchain again. Over the time that this paper Trough of Disillusionment
Technology Trigger
Time
was researched and written, the price of a single
bitcoin has gone from about $1,200 to over
$25,000 and is now back to about $10,500 (CAD). Source: Kemp, J. 27 December, 2007. File: Gartner Hype Cycle.svg.
74 | INSIDE THE BLACK BLOCKS

Wikimedia Commons. CC BY-SA 3.0. https://commons.wikimedia.

The fluctuation in the price of ether was even org/w/index.php?curid=10547051.
more significant with it starting 2017 at about
$12.00 rising to more than $1,800 in the crypto- 168 All values as of 25 July, 2018. See https://ca.investing.com/
mania of December 2017-January 2018. It has crypto/currencies.
169 Nishizawa, K. 6 February, 2018. “Get Ready for Most
Cryptocurrencies to Hit Zero, Goldman Says.” Bloomberg. https://
www.bloomberg.com/news/articles/2018-02-07/get-ready-for-
most-cryptocurrencies-to-hit-zero-goldman-says.
Given that blockchain seems to have gyrated In closing, we emphasize again just how
up to multiple “Peaks of Inflated Expectations” essential it is to think of both the benefits and
– largely on the back of cryptocurrency- and the challenges associated with blockchain as
ICO-related financial speculation which has being inextricably linked with other emerging
muddied public understanding of the underlying technological developments such as AI, big
technology – it is hard to say where on this graph data and IoT. Because of this, it is essential that
we currently find ourselves. The most likely policymakers be able to think of how they are
point, however, is somewhere between the “Peak going to respond to these technologies in these
of Inflated Expectations” and the “Trough of terms. The usual siloed government thinking,
Disillusionment.” 170
This means that the next few whereby one department or regulator assumes
years will likely be when we move onto the “Slope responsibility for one thing while another focuses
of Enlightenment” and start to find out how useful on another without communicating very well
and impactful blockchain will actually be. with each other, will end badly. Fortuitously,
however, blockchain itself – and the transparency
As this report has indicated, there are two main and cooperation it can enable – might just help
categories of blockchain-related questions governments find a way to overcome this all-too-
that policymakers face. The first concerns persistent bad habit.
the impacts that this technology will have on
the wider economy and society. The second
concerns the potential uses that this new
technology might serve for government in its
own operations. To help policymakers answer
both categories of questions, we have outlined a
series of steps that governments ought to take,
including building internal capacity, fostering an
attractive environment for innovation, supporting
experimentation with the technology, helping
to fashion standards and flexible new tools to
govern it, and working with other governments
to develop the capacity to minimize its threats to
their citizens and maximize its benefits.
GAMEX x BLOCKCHAIN x NFTs
x 3D & VIRTUAL PRODUCTION

BLOCKCHAIN x the REAL

BUSINESS of BLOCKCHAIN
75 | THE MOWAT CENTRE

170 Gartner, the firm that developed the hype cycle concept,
agrees with our assessment in terms of blockchain’s current
positioning in the cycle. Panetta, K. 15 August, 2017. “Top Trends
in the Gartner Hype Cycle for Emerging Technologies.” Gartner.
https://www.gartner.com/smarterwithgartner/top-trends-in-the-
gartner-hype-cycle-for-emerging-technologies-2017/.

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