Regulation Special: The Hierarchy of Liability

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The functioning of the blockchain technology is beyond the logic of the state. States, central banks and supervisory authorities are overburdened because they do not know how to regulate a system that is not central. Although there are always position papers on the subject of digital currencies, they are often without concrete instructions on how to regulate them. Our regulation special dares to take a step into possible options. Today: Who is liable?

“We want to regulate Bitcoin better in the future.” That or something similar is the sound of efforts by politicians and regulators in all countries. But how is that supposed to work?

If you recall the characteristics of Bitcoin formula, you can see the problems of regulation

By definition, Bitcoin formula is known to be pseudonymous, cryptographic and decentralised: In the latter attribute lies the crux of the matter, if you ask yourself how to regulate the crypto currency. Is it possible to regulate a crypto currency that comes from all corners of the world just like that? If so, who is responsible?

Only recently the Bafin published a letter in which it pointed out that when classifying crypto currencies and ICOs one must always decide on a case-by-case basis. Accordingly, crypto currencies are mainly classified as financial instruments, securities or investments. The Bafin initially shifts responsibility to the initiators of ICOs, because

Market participants who provide services with regard to tokens, trade in tokens or offer tokens to the public are required to carefully check whether a regulated instrument, i.e. a financial instrument within the meaning of Section 2 (4) WpHG or a security within the meaning of Section 2 no. 1 WpPG, exists in order to fully comply with any legal requirements.

Liability according to Bitcoin trader

Bafin’s proposal is partly in line with a working paper on the subject by a Bitcoin trader research group like this: In a comparison of German and French law as well as common law, they finally came to the conclusion that it makes sense to establish a hierarchy of people involved in the respective networks. Depending on the involvement and responsibility within the various networks, liability also arises. According to German law, the blockchain must normally be treated like a GbR or OHG with the corresponding rules. They propose the following hierarchy:

Developers who are responsible for the code and create the technology; owners of servers; “qualified users” (such as Exchanges or Miners); “simple” users; third parties who do not actively participate in the system.

Furthermore, it is necessary to clarify who is responsible for the data and whether the use of the data is compatible with the respective national laws. The distribution of data over individual nodes (see our What about Ledgers series) could violate the data protection laws of some countries. For example, Bitcoin is theoretically able to obtain information about users from individual nodes and personalise the apparently unpersonalised data again – the network is pseudonymous, not anonymous. Entities using block-chain applications must address these issues and review their respective data security policies. Once the framework has been worked out, the technology itself can be used – and Smart Contracts can be used, for example, to ensure that the respective national laws are observed.

The problem that joins this question is the fact that the blockchain does not forget – all data is stored forever. This can cause massive problems for individuals or companies working with the blockchain. In the event that incorrect data is fed into a system, it can no longer be deleted. Everyone who works with blockchain solutions must always keep this in mind. A regulatory approach also has to deal with this.

What was that like again?
If one follows the proposal of the working paper of the European Banking Institute, a hierarchy of participants makes sense. The more you deal with the network, the more liable you are. From top to bottom: Developers – server operators – qualified users (exchanges/miners) – simple users – third parties.

Types of forks

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To understand the explanations, you should know what nodes are all about. In brief, the nodes store the blockchain as network nodes and make it available to the network. At best, the current consensus of the blockchain, i.e. the most recent transaction history, is stored decentrally on all nodes.

All nodes in the network must be operated with compatible software so that they can agree on a blockchain. If a change proposal is submitted, there are two ways to perform the fork:

Soft fork and the Bitcoin code review

A soft fork is characterized by its downward compatibility. So there may be nodes in the network that work with the new software review. This does not lead to compatibility problems: The nodes with the old software also accept the opinions of the users who have now opted for the new software. On the other hand, the users want to establish their Bitcoin code review standard with the new software and therefore rely on their new procedure for all blocks.

As soon as the majority in the network is reached, all nodes agree on the new blocks. “Old” and “new” nodes continue to work together

Hard fork and the Bitcoin code scam

This type of fork is not downward compatible – and therefore poses special challenges to guarantee consensus in the network. Existing nodes must update their software to take the new blocks into account (in the Soft Fork, existing nodes could simply take the new blocks into account due to compatibility). The incompatibility of the versions means that the Bitcoin code scam network can be split, so to speak: Users who speak for or against accepting the changes then operate on different blockchains. This is called a blockchain fork (not comparable to a software fork). It is important to stress that not every hard fork creates a new, stable blockchain. Ethereum now has five hard forks behind it and only one of them has formed a new blockchain with Ethereum Classic.

“Old” and “new” nodes go their separate ways. Two blockchains can be created.
How is a fork performed?
Let’s take a look at a fork using Bitcoin as an example. The Bitcoin Core Team may be able to suggest changes – but they can’t enforce them alone. Ultimately, the miners decide which block chain to follow. This preserves decentralization because the network is also left with decision-making authority here. The core team can certainly push ahead with further developments – but it has to keep pitching before the miners and hoping for acceptance.

In the past, Ethereum and Ethereum Classic were indeed a decisive split of the Ethereum blockchain: After the DAO hack, the community intensively discussed undoing the transfer of the hacked coins by agreeing on a blockchain that does not include this transfer. Of course option A) Hacker may keep his loot with option B) Action of the hacker is reversed is not compatible. The procedure therefore requires a hard fork. And as long as 100% of the participants do not agree on a version, the blockchain is split. This happened because now two Ethereum blockchains exist: Ethereum Classic (without Hard Fork: the hacker remains in possession of the stolen coins) and Ethereum (with Hard Fork: unwanted transaction was reversed).

More information about Ethereum and Ethereum Classic can be found here.

Now there are different ways to perform a fork – not to be confused with the different types of forks.

Miner Activated Fork
In this case, the miners in the network decide whether to perform a fork. They signal that they want to perform the fork by attaching this information to confirmed blocks. If within the last 1000 blocks a sufficient amount of miners has signaled the fork, the changes will be enforced. For example, the new version becomes valid from 75% approval, from 95% even old blocks that are not marked with the new version are rejected.

User Activated Soft Fork (UASF)
The User Activated Soft Fork (UASF) is a fork that is triggered by a majority decision among the full nodes. It is terminated on a certain date on which the majority of full nodes must agree to it in order for the fork to actually take place.

Miner Activated Soft Fork (MASF)
With a Miner Activated Soft Fork (MASF), the miners use their computing power to decide on the fork as their voting right and initiate it. This makes the process more efficient, as the full nodes can then accept the changes. However, MASF entails risks because the network relies on computing power as a benchmark. In this way, the Re

The SEC has presented interested investors with a list of arguments

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Many open questions: The SEC has presented interested investors with a list of arguments put forward by the applicants as well as general questions on the subject, which they can work through in their next comments.

Is the Bitcoin ETF really not manipulable?

The CBOE argues that the VanEck SolidX Bitcoin Trust is better protected against manipulation than other physically covered exchange products. This is partly due to the global fragmentation of the Bitcoin markets and the continuity of Bitcoin trading. In addition, its low transaction speed makes the Bitcoin less susceptible to manipulation attempts.

2nd OTC and Arbitrage. Next, the SEC cites an argument from the Bitcoin ETF sponsor SolidX. The sponsor argues that over-the-counter (OTC) trading, which is used to determine prices, is more suitable than the index of one (or more) exchanges.

The SEC also requires information on the number of traders on OTC bit-coin markets, their liquidity and whether sufficient arbitrage has been provided.

IIV and NAV. Can the dissemination of information via the fund’s website contribute to making manipulation attempts less likely? What about intra-day indicative value (IIV) and net asset value (NAV)? manipulation: general Fourth, the SEC asks the commentators for their general opinion on the susceptibility of the proposed Bitcoin ETF to manipulation.

Manipulation of Bitcoin futures

The SEC asks investors and interested parties to comment on the general resistance of Bitcoin future markets to manipulation in the fifth item of its list.

The Opaque Index
The Commission wants to know from investors how they feel about the fact that the calculation of the index used (“MVBTCO”) is carried out using a private method and is based on the quotes of non-identified market makers? And: Does the time of the daily price determination, 16:00 EST, make the Bitcoin ETF more susceptible to manipulation?