Hack Night With Mark Weber

Dazza Greenwood edited this page Feb 8, 2017 · 3 revisions

Hacking Electronic Transferable Records

Join us for a focused legal hack session with Mark Weber of the MIT Digital Currency Initiative as we help solve for the legal aspects of transitioning paper-based warehouse receipts into the form of blockchain-backed digital, networked objects!

The general idea is to refactor legally valid and enforceable warehouse receipts from paper documents to digital records. For purposes of making good progress and helping to provide a solid starting point to work with, we will explore:

1) Identifying system design requirements or constraints by starting with a walk through of the rules governing "Transferable Records" under UETA and ESIGN; and

2) Identifying contract design requirements or constraints by starting with a walkthrough of a standard, international "Trading Partner Agreement" appropriate for participation in relatively open commerce platforms, exchange networks and multi-player market systems (not a big buyer supply chain trading partner).

The goal for this hack night is to develop a bullet list of potentially important legal requirements, constraints and other design goals derived from a rapid but focused walk through of relevant legal rules. The intention is to derive that bullet list from legal rules governing warehouse receipts in the form of electronic transferable records in the practical context of some likely types of rules governing parties using the digital warehouse receipt system derived from very standard trading partner and other commercial umbrella agreements. While these two sources are far from comprehensive sets of all the legal rules impacting a system for digital warehouse receipts, they do provide a core "DNA-like" set of coherent, widely accepted, authoritative, definite, timely, relevant and achievable foundation to build upon.

------- Background/Contextual Materials --------

Trading Partner Agreement Standard Examples:

Electronic Transferable Records materials:

Federal and Uniform State Law

The legal validity of Electronic Transferable Records was explicitly established in the US through UETA (as uniform state law) and ESIGN (federally), both of which (broadly) were implementations of the UNCITRAL Model Law on Electronic Commerce.

UNCITRAL

Good Background Materials

"Control" of Transferable Records: Issues and Options

Relevant Interests of Mark Weber

Comprehensive UNCITRAL Bibliography

UNCITRAL Bibliography of Relevant Articles:

Mark Weber's Warehouse Receipts Project

Background

I. The social and economic impact of improving warehouse receipts

As the Peruvian economist Hernando De Soto famously noted in The Mystery of Capital, emerging market countries have trillions of dollars of “dead capital” assets waiting to be unlocked and fully deployed in the economy to generate shared prosperity. While De Soto has focused for decades on land title, a highly contentious and culturally sensitive topic, we see warehoused commodities as an overlooked opportunity to achieve this same vision for a more robust social and economic ecosystem.

Every day in our increasingly global economy, producers of various commodities use warehouses to store the fruits of their labor until favorable pricing motivates the sale of those goods. In advanced systems, the corresponding warehouse receipts can be pledged as collateral to access credit and facilitate trade, producing numerous benefits for societies and economies. [1]

However, inefficiencies and malfeasance in existing systems stifle credit flows as a function of lending risks, prevent widespread access for small-medium producers, and heighten systemic risks[2] to the economy.

In 2014, for example, a $10 billion dollar trade finance fraud was uncovered in China. The perpetrators at the Qingdao and Penglai trade ports used the same storage quantities of metal repeatedly as collateral against multiple loans at once, resulting in billions of dollars of loans backed by nothing. The ramifications were massive. Standard Chartered reported a 20% drop in 2014 earnings resulting from their $250 million exposure to Qingdao.

Independent of malfeasance, substantial frictions exist due to the structural limitations of paper-based registries and even traditional digital databases that fail in key areas of accessibility, interoperability, and security. Creative syntheses of technology, law, and policy can improve these systems to generate inclusive prosperity and reduce poverty.

II. Imagining a globally distributed system of record with coded permissions and digitally enforced contracts based on account balances

In week one, a depositor arrives at a warehouse with 100 units of corn to store. Upon entering the compound, the depositor checks in to the digital system with his unique digital identification (a public key represented by a QR code) associated with his account. A warehouse employee, also checked into the system upon arriving at work, opens the depositor’s account and begins processing the 100 units according to standard procedures. The digital devices he uses to evaluate the corn, for example a digital weighing scale, offer read-outs that the warehouse employee records manually using a smart-phone or tablet application, but the digital devices themselves also participate as users in the system writing to the account entry. Thus, the digital devices and the employee serve to verify and/or dispute one another’s entries. Upon completion of the deposit, the depositor and the employee sign the deposit with their respective private keys. The details of the deposit are recorded in the account transaction activity, stored in a cryptographically-secured IPFS[3] distributed database, and hashed to the Bitcoin blockchain with a micropayment of a few cents. The depositor’s account balance automatically updates to reflect the 100 units of corn and corresponding market value updated every second.

The depositor decides prices are not yet favorable to sell the corn and he could benefit more from a loan to purchase a tractor. He arrives at his bank, which has installed software packages to communicate with the commodities registries and the Bitcoin blockchain. The depositor provides his public key for the loan officer to pull up his account and declares he would like to pledge 100 units of corn as collateral for a $1000 loan. The loan officer signs into the system with his public key and runs a yes-no query to the depositor’s account (he cannot see the depositor’s total balance). The query verifies that the depositor indeed has 100 units to pledge and that these units have no existing liens against them. Based on the bank’s predetermined valuation framework, which locks in the price of the corn for the purpose of the loan, the loan officer offers a $1000 loan at 0% interest[4] with the stipulation that the loan must be repaid within thirty days or will otherwise default, at which point the ownership permissions of the units of corn corresponding to the unpaid amount will automatically shift to the owner of the security.[5] To finalize the loan, the depositor and the loan officer sign a digital, self-executing contract with their respective private keys. Upon signing the contract digitally, $1000 is issued to the depositor’s account and the digital permissions associated with his 100 units of corn are automatically restricted by the system protocol. The 100 units still belong to the depositor, but the system will not allow him (nor the holder of the security) to withdraw them or pledge them as collateral for a loan while the loan is still outstanding.

In week 2, the price of corn rises by 50% and the depositor conditions are now favorable to sell 50 units of his corn. He has a buyer within the railway distribution network of the warehouse, so the warehouse can handle the shipment directly from storage. The buyer also uses software packages that communicate with the commodities registries, the warehouses, the banks, and the Bitcoin blockchain. From a distance over the internet, the depositor provides his public key to the buyer and the buyer runs a query on 50 units with the price the buyer is willing to pay per unit. As long as this price matches or exceeds the per unit price fixed in the depositor’s outstanding loan, the system will allow for a sale of those units to the buyer in exchange for the appropriate payment to the depositor’s bank account. The buyer and depositor agree in principle to a $750 sale of 50 units of corn to be delivered by train by the warehouse, with a “Net 15” payment upon receipt and examination of the goods. The buyer and depositor then sign the transaction with their respective private keys, triggering the shipment of the goods from the warehouse. The depositor’s account with the warehouse is reduced by 50 units.

In week 3, the buyer receives the 50 units of corn with satisfaction. He opens the system application on his smartphone and presses a button to execute the payment agreed upon digitally in the contract. $750 is transferred from his bank account to the depositor’s. When the fund’s hit the depositor’s account, the contract corresponding to the sale is complete. The depositor directs the entire amount to pay off 75% of the securitized loan from the bank.

In week 4, the price of corn falls by one-third back to its original price to start the month. Unfortunately, in the final week of the loan, the depositor does not have cash to repay the remaining $250 balance on the loan and he cannot find a buyer to purchase the remaining 50 units and remit payment in time to meet his loan repayment schedule. Thus, at the bank’s closing hour on the 30th day of the loan, as stipulated in the lending agreement, the contract is digitally enforced with an automatic transfer of ownership permissions for 25 units of corn from the depositor to the holder of the security. The new owner of those 25 units, formerly the holder of the security, may choose to hold those units in the warehouse or automate the liquidation of those assets in a previously determined contract with the bank and/or the warehouse. The depositor maintains a 25-unit balance of corn at the warehouse.

Meanwhile, as citizens all over Mexico and Latin America use various software packages to participate in this integrated system for everyday transactions with one another, economists, regulators, law enforcement officers, and policy makers use their own software packages to monitor associated economic activity while still protecting the privacy of individual users in the system. An economist in studying competitive advantage opens her laptop to analyze the monthly volume of corn sales in Mexico. A regulator in Mexico City monitoring risk in ABS markets opens his laptop to see what fraction how many total units of corn are currently stored in Mexico and what fraction of those units have outstanding liens against them. A law enforcement officer investigating a fraud connected to the warehouse system opens up the account in question to review which warehouse employees signed which transactions, trusting that the records could not have been tampered with thanks to the immutability of the Bitcoin blockchain ledger. A policy maker interested in incentivizing investments in advanced irrigation systems prints out macroeconomic agricultural data for a presentation to an industry association of growers.

[1] “Designing warehouse receipt legislation: regulatory options and recent trends.” Food and Agriculture Organization of the United Nations, 2015.

[2] The 2008 financial crisis was in large part a result of opaque ABS markets.

[3] Inter-Planetary File System.

[4] 0% interest rate chosen for simplicity.

[5] It is common for banks to sell these asset-backed securities to other investors and companies.