Can blockchain technology help prevent fraud?

August 1st, 2018

By Kgomotso Ramotsho

Werksmans Attorneys hosted a seminar on blockchain technology. The seminar was held in Johannesburg on 7 June. Consultant at the Blockchain Academy, Carel de Jager, said blockchain is a ledger that is broken into hundreds and thousands of blocks. He added that each block contained transactions and a new block is updated every ten minutes. He pointed out that it is important to note that each block is mathematically connected to the block behind it and in front of it and if a person tried to change a transaction, the entire structure of the blockchain would change.

Consultant at the Blockchain Academy, Carel de Jager, spoke at the blockchain seminar hosted by Werksmans Attorneys, in Johannesburg on 7 June.

Mr de Jager added that when a certain blockchain is tampered with, it will not look similar to the correct structure of the blockchain. He said it is easy to spot a blockchain that had been tampered with, because they are mathematically connected to one another. He pointed out that a person needed to be able to prove that they are the owner of a blockchain through cryptography, which meant that an owner had to have a private key to that blockchain. He noted that most private keys were 32 bytes in number and what that meant was the owner could derive a private key from any input they wanted to.

Mr de Jager said, for example, the owner could take their fingerprint and send it through a mathematical algorithm and then receive a private key, or the owner could provide DNA or, even provide 12 unique words that they would use as their private key blockchain. He noted that blockchain can be a piece of digital data, such as a titled deed to a property, medical records, share certificates or even electricity units, he said it could be anything that can be described in a digital manner. He added that for business use, businesses could build all functionalities of smart contracts on blockchain. However, he pointed out that businesses or investors should rather opt for a private blockchain, rather than a public blockchain, because with a public blockchain, anyone with an Internet connection will be able to see what is happening unlike on a private blockchain, where it works like a database.

Managing Director at AJR Corporate Financial Services, Alain Jacques Renard, said that blockchain is very impressive technology, however, he added that there are challenges attached to it. He pointed out that some of the risks linked to blockchain included: Infrastructure; hardware; software malfunction, either, accidental or malicious; and the possibility to create a fake copy of the blockchain website to scam investors. He noted that automation with blockchain is not always fast, and when financial services have to contract on behalf of multiple clients, they cannot use the platform, instead making phone calls is faster than an automated system. He added that another challenge with blockchain was that the administrator of blockchain was unknown and that if investors were to experience a problem with blockchain, where would they go?

Managing Director at AJR Corporate Financial Services, Alain Renard, spoke about the challenges of blockchain in the financial sector.

Mr Renard said blockchain can be introduced in financial transactions. He added that payments between parties can be made through blockchain, however, he pointed out that he was worried that blockchain administrators would then have to be the banker and a custodian of the fund. He added that on financial markets, blockchain could be classified as an over the counter transaction. Mr Renard said blockchain could be used in financial transactions, provided there was transparency and the administrator was known to the user. He added that communication between parties must always be possible.

Director at Werksmans Attorneys, Natalie Scott, said there are three types of blockchains, namely –

  • public blockchains;
  • private/enterprise blockchains; and
  • consortium blockchains.

She added that a public blockchain is an Internet protocol that manages the distribution of unique data that –

  • acted as a unit of account for transactions on that ledger;
  • transactions are immutable;
  • it was an open source protocol;
  • it enabled innovation such as sidechains or scripting;
  • it was easy to audit; and
  • there are incentives for early adopters and developers to use, support and verify the ledger without the need for a trusted third party/intermediary.

Ms Scott pointed out that a public blockchain contained authentication and verification technology. She said it is claimed to be less open to corruption and borderless. She added that it is frictionless, and that there is anonymity and most widely understood application for money transfers and payment in Bitcoin. She noted that public blockchains prevented a ‘double-spend’ by a proof-of-work validation system, which disallowed the electronic units of value to be copied. Ms Scott gave examples of public blockchains, which include –

  • Bitcoin;
  • Ethereum;
  • Google; and
  • Amazon.

Director at Werkmans Attorneys, Natalie Scott spoke on regulations in regard to blockchain on 7 June.

Ms Scott spoke about the enterprise blockchain, she said it was a private blockchain and was consensus driven via trusted intermediaries who are identified. She pointed out that the network was permissioned, and that digital currency was not necessarily required. She added that enterprise blockchain offered solutions to persons who wanted to use a cryptographic database, which was managed and stored by trusted third parties and their intermediaries. However, she noted that the data subject identity details are disclosed, so there are reduced privacies.  She said examples of enterprise blockchain, included –

  • Ripple;
  • Chain;
  • Hyperledger;
  • Oracle; and
  • IBM.

Ms Scott said consortium blockchain was built on the public blockchain architecture and was partially decentralised. She added that a consortium blockchain provides technology for permissioned networks (pre-selected nodes), for example, ten financial institutions jointly operate a blockchain and each controls a node, but at least eight financial institutions are required to sign a block, for the block to be valid. She added that the right to read transaction data may be private or public and can be permissioned, on a case-by-case basis. Ms Scott identified the regulatory role players role of blockchain, which include the –

  • South African Reserve Bank (SARB);
  • Prudential Authority;
  • National Treasury;
  • Financial Intelligent Centre;
  • National Credit Regulator;
  • South African Revenue Service;
  • Strate;
  • Johannesburg Stock Exchange;
  • Commissioner at the Companies and Intellectual Property Commission; and
  • Financial Sector Conduct Authority.

Ms Scott added that one of the big issues in terms of blockchain technology and contracting via blockchain is determining jurisdiction. She said regulation looks at the governing laws that speak to blockchain. She pointed out that in terms of issues of offer and acceptance, there is a law and contracts that speak to where the offer is made and when acceptance can be received, which varies from jurisdiction to jurisdiction. She said with regards to the ostensible authority some countries do not recognise ostensible authorities of the contracting parties, she then asked how do you know you have a valid contract?

Ms Scott pointed out that there are decentralised autonomous organisations (DAOs) that automatically execute smart contracts, however, she added that DAOs have no legal persona and run on predetermined scripts as there is a protocol for them to act as they automate the process. She said the enforcement of rights is one of the contractual issues that an investor should bear in mind. If something goes wrong, where do you go, who do you sue and under what laws and what happens if you have conflicts of laws? She added that confidentiality was another thing an investor should look at. Ms Scott pointed out that confidentiality does not work in an open blockchain where a banker and client’s confidentiality can be compromised as it is available for determination by all nodes on the network.

Ms Scott touched on some of the regulations in regard to blockchain such as:

  • The SARB has said that cryptocurrency is a ‘cyber-token’, and not a legal tender. Merchants are not obliged to accept ‘cyber-tokens’ but are legally obliged to accept legal tender. Payments made via cryptocurrency may not be considered to discharge monetary obligations, because it is not recognised as ‘money’ in law.
  • Income Tax Act 58 of 1962: Cryptocurrency is not considered to be a currency, but as an intangible asset, which is to be included in the income tax return.
  • Currency and Exchanges Act 9 of 1933: Capital outflows are regulated and allowance is made for an annual single discretionary allowance or an annual foreign investment allowance. The SARB may require approval and tax clearance certificates. Investors should be careful of offshore/international exchanges.
  • Protection of Personal Information Act 4 of 2013: The effective date is still pending. The intention is to safeguard the ‘personal’ information of a ‘data subject’ when information is ‘processed’ by a ‘responsible person’. Lawful ‘processing’ of ‘personal information’ requires eight conditions of the European General Data Protection Regulation (GDPR) to be fulfilled (see feature article ‘Unscrambling data Protection Regulation’ at p 32).
  • Consumer Protection Act 68 of 2008: Describes any scheme that offers return of 20% above the repo rate as a ‘multiplication scheme’, for example, a Ponzi scheme.

Kgomotso Ramotsho Cert Journ (Boston) Cert Photography (Vega) is the news reporter at De Rebus.

This article was first published in De Rebus in 2018 (Aug) DR 11.