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In this blog series, Legal Future takes you into the world of blockchain. This revolutionary technology sees more applications every day. How does it work, how can it be applied, and what are its advantages and disadvantages? From a legal perspective, how does this technology fit into national legal systems? Should this technology be regulated by governments in the near future? Interesting questions that we’ll dive into in this blog series. In the next couple of blogs, we’ll discuss some of these topics. In this blog, the functioning and uniqueness of blockchain is highlighted. Keep reading below the picture.

Current digital payments versus blockchain payments

Blockchain is best explained using the internet as an example. The internet is a digital environment where people store and exchange information and make online payments. Although the internet is used by almost everyone around the world today, it is far from safe. Its users are vulnerable to hackers, scams, and other criminal acts. In the case of making payments on the internet, which is done through traditional methods of banking. To do so, one still needs an intermediary. Usually, this is a bank, to transfer the money to someone else. This increases transaction costs because banks are service providers that need to be paid. Besides the costs, it can take a few days. Especially in the case of international transfers, before the money has reached its destination. This process is making it time deficient. 

Contrarily, Blockchain is quite revolutionary and tackles most of the weaknesses of the internet. This technology (literally: chain of blocks) is a distributed ledger technology. This means a decentralized digital system in which blocks containing specific and unique information are added to the chain. Decentralized means without a central authority, as each participant stores and observes the entirety of the chain of blocks. The technology was originally introduced to make payments safer, quicker and less costly. It did not take long before the first cryptocurrency, Bitcoin, was launched. 

Blockchain transactions explained

How does a blockchain transaction work to begin with? Each new block holds transactional data and a timestamp, which holds information on the previous block in the blockchain. This way, each transaction is validated before being added to the blockchain. Each block has a unique 64-bit hash code which is generated by a mathematical algorithm. You can use this hashcode generator (SHA256) to transform any text into hash code to get an idea of how encrypting data works. Once a block has been recorded to the blockchain, its data can not be altered or modified without changing all subsequent blocks. 

This makes it virtually impossible to hack the blockchain. Banks are the only supervisors of suspicious transactions in traditional banking. Different from ‘old’ digital transactions, the blockchain, fraud is immediately visible to all participants. Blockchain has many applications. In addition to making payments, the technology is used, for example, in cryptocurrencies, NFTs (non-fungible tokens) and smart contracts. 

Potential disadvantages of blockchain

It can be argued that a disadvantage of blockchain and cryptocurrencies is their anonymity. As explained above, blockchain networks are shared with all participants. Who performed a transaction is visible by showing a person’s ‘public key’. This key is a string of random numbers and is impossibly traceable to someone’s private key. This private key is again a string of numbers.

The anonymity would encourage money laundering and tax evasion. The Dutch tax authorities have already indicated that owning cryptocurrencies qualifies as assets on which tax must be paid. As usual in tax law, the responsibility for declaring these assets lies with the declarant. In favour of anonymity, pleads the privacy argument. Because blockchain is a decentralized system, it is not desirable to show people’s real names. This would infringe on their fundamental human rights. After all, transactions are accessible to all participants on the network.

In the end, this blog has tried to explain the basics of blockchain technology. It has shown some of its applications, as well as its possible benefits and downsides. In the next blog in this series, some use cases will be explained in greater detail. These cases will lead to the legal implications of blockchain and the discussion on the need for regulating blockchain.

Interested in learning more about the legal implications of blockchain technology? Check related blogs here.

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