The impact of DLT, digital assets and smart contracts on investment law & regulation

Ann Sofie Cloots

Faculty of Law - Darwin College - University of Cambridge - UK

Abstract

Digital assets, distributed ledger technology (DLT) and smart contracts present new opportunities and challenges for investors and investment law. The mantra ‘blockchain, not crypto’ has gradually made place for a more positive assessment of the potential for digital assets to facilitate investment. Particularly following the controversial announcement of the Libra token, governments worldwide have started to re-assess the benefits of digital assets, both private and public (Central Bank-issued Digital Currencies or CBDC). Private digital assets include, for example, tokenized securities, investment contracts or trading documents. Another type of private digital asset is a private settlement token such as JPMCoin. Central Banks are now considering the potential benefits of CBDC, not only to prevent private stablecoins from gaining dominance over fiat currencies, but also as CBDC may smoothen investment transactions. Whether or not digital assets are combined with DLT or centralized databases, they can be combined with increasingly sophisticated smart contract capabilities to facilitate investment transactions. This has the potential to lower investment costs, speed up investment transactions, automate aspects of an investment contract’s lifecycle and increase transparency and auditability of investment transactions. However, technological innovations in the field of investment also raise certain challenges for investment law and regulation. Depending on the specific implementation, a number of legal and non-legal challenges arise, including credit and systemic risk, AML/KYC, cybersecurity, coding errors and liability, conflicts of law and investor protection. Moreover, in order to capture the potential benefits of these technological innovations for investors, a certain level of standardization will be required. A number of private and public initiatives are attempting to streamline legal taxonomy (e.g., ISO), legal standards (e.g., FATF, BIS) or technical standards (e.g., ISO, ISDA). Moreover, heightened attention by international bodies such as the BIS, FSB, G7 and IMF are refining the legal debate on stablecoins and automation of commercial transactions through the use of smart contracts and DLT. These new technologies do not only pose potential risks for investment lawmakers and regulators. The legal and regulatory framework on investment can also be facilitated by these new technologies. For example, investment regulators could use these technologies to obtain real-time data streams about investment flows. This could help with risk management mandates, as it may allow for more accurate and timely risk assessment. Moreover, the technologies could be used for so-called RegTech in the investment sector: smart contracts, DLT and digital assets could be used for reporting and compliance monitoring. This could mean that regulators become ‘users’ of these new technologies, in addition to being monitors of investment patterns and risks. The paper will describe a number of pilot projects and applications using DLT, digital assets and/or smart contracts for investment purposes. It will assess how these projects affect investment development, both negatively and positively. In addition, it will formulate a number of general conclusions about the future of these technologies for investment law and policy.

Keywords

investment law, smart contracts, distributed ledger technology, digital assets, transaction costs, law & technology