From blockchain-based payment systems to clients’ token offerings, law firms are increasingly finding themselves giving advice around digital assets, blockchain, and other forms of distributed ledger technology (DLT). Given the evolving regulatory landscape, law firms must be knowledgeable and straightforward on the advice they provide to clients.
What is blockchain technology?
Blockchain is a type of digital network or database for recording transactions. In contrast to a traditional ledger, blockchains have no central store of data or administration. Instead, multiple parties can share and update transaction details on a decentralised basis without relying on a trusted third party.
The blockchain is currently the most common form of DLT. The breadth of use-cases for the technology are vast and vary significantly from sector to sector.
Potential areas on which firms may be asked to provide advice to their clients include where there’s use of the technology for:
Paying (or receiving payment) using cryptocurrencies, or using digital wallets or exchanges
Purchasing and selling non-fungible tokens (NFTs)
Record keeping (e.g., in healthcare or property transactions)
Privacy and data security queries relating to the use of blockchain technology
Money laundering or regulatory risks relating to the use of blockchain technology, and complying with regulatory requirements
Like with any other advice given to clients, understanding exactly where/how the client is using blockchain technology is important when advising clients to ensure that the advice given is relevant, accurate, and correct.
Advising on matters involving blockchain technology
Areas to be mindful of when advising clients on matters relating to blockchain technology include:
Evolving laws and regulations about blockchain use. Firms need to ensure that they are keeping up to date with any advancements and ensuring that their advice to clients remains accurate. This is particularly important where a firm wants to be perceived as a specialist leader in advising clients on blockchain matters.
Privacy issues. The anonymous nature of certain forms of blockchain technology may raise additional concerns around risks of fraud or money laundering crimes taking place. Law firms may need to perform robust checks in circumstances where blockchain may be used (e.g., where a client wants to use cryptocurrency in a transaction) because tracing the source of funds may be more difficult.
Errors and mistakes. Accuracy and attention to detail are important where a law firm may be asked to carry out a task involving blockchain (e.g., filing a record on a system using blockchain). If a digit or character is wrong, it could potentially have costly consequences. Rectifying the action may be complex.
Insurer perspectives on blockchain and digital assets
In some countries, solicitors are required to maintain appropriate Professional Indemnity (PI)/Errors & Omissions (E&O) insurance which provides coverage for civil liability arising from private legal practice while in others, it’s just good risk management hygiene.
PI/E&O insurers are closely monitoring the rapidly developing field of blockchain and digital assets, and will expect firms to take reasonable steps to mitigate against potential emerging risks.
Strategies to mitigate risk include:
Invest in understanding. The sector is fast moving, and risks for law firms can rapidly grow if not responsibly managed. Firms’ first line of defence will be knowledge, investing in people who understand the nuance from a technology perspective, as well as a legal one.
Ensure AML processes are up to date. Anonymised cryptocurrencies carry certain risks. Firms may be exposed to such risks without warning, for example if an estate being handled in probate proves to include crypto assets. Firms should stay abreast of the latest AML guidance and governance procedures and ensure these are adhered to and implemented by all staff, with knowledge regularly refreshed.
Protect against value instability. The value of current cryptocurrencies is highly volatile. Where firms are holding clients’ crypto assets as a means of collateral of an underlying fiat currency, issues may occur where there is a massive shift. Using stablecoins is one way in which such risk can be minimized.
Evaluate your (ancillary) custody risks. Firms in charge of estates’ holdings may find themselves placed with the responsibility of either serving as direct custodians (e.g. being asked to hold or store physical wallet devices) or sourcing third-party custodians. If these go wrong, a firm could be brought into litigation, specifically around the holding of or securing of assets. Firms should ensure they understand the role of custodians and that they have the knowledge and infrastructure capabilities to protect clients’ assets. If working with third parties, firms should seek out specialist advice to ensure appropriate custodians are selected, with sufficient insurance in place as a backstop to potential losses.
Mitigating against these risks will ensure law firms remain at the forefront of evolving technologies for the benefit of client advice.
For more information, reach out to a member of our team.
