Blockchain and the First Law of Lawmodynamics.

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When someone says that they’ve engineered risk out of a commercial transaction, I think about two things:  mortgage backed securities and the first law of thermodynamics.

Remember 2008?  Mortgage backed securities and CDOs almost made ATMs stop running.  Turns out that “risk free” investments weren’t really.  Marketing fell victim to reality.  Many people suffered as a result.

A guy in financial services explained to me in 2006 that risk had been engineered out of MBS with insurance, tranches, and “over-collateralization”. I’d spent some time handling real estate litigation and had read through my share of loan files, so asked what to me was an obvious question:  how anyone would foreclose on the collateral, as it wasn’t always clear who held it.  His answer, nearly verbatim:  “it’ll never happen, we’ve engineered the risk away.”[1]  (I wondered, but didn’t ask:  why take the collateral if you don’t think you’ll ever need it?)

The first law of thermodynamics says energy “cannot be created or destroyed. It can, however, be transferred from one location to another and converted to and from other forms of energy.” [ 2].  Maybe the same is so of liability and damages.  You can’t destroy or avoid either building a better mousetrap. You can only move it, or (arguably) move the consequences of that liability elsewhere.

What does that have to do with , or any other new and “disruptive” ?  Consider Judge Rakoff’s recent opinion in the Uber antitrust litigation in the Southern District of New York.  Summarizing: Uber may be really, really big and the technology really cool, but that in and of itself may actually create a different kind of really, really big liability. As the court puts it: “The advancement of technological means for the orchestration of large-scale price fixing conspiracies need not leave antitrust law behind.”  [3].  Innovation and disruption made a new, different and larger liability possible.  Bigger opportunity, meet bigger risk.

You may think that Judge Rakoff was wrong or disagree with the Silk Road opinion, which he cites. You’re free to.  This observation is hard to argue with, though, as an historical fact:  “Throughout the history of the common law system there have been times when laws are applied to new scenarios. At each new stage there were undoubtedly those who questioned the flexibility of the law. But when the principles underlying a law are consistent and clear, they may accomodate new fact patterns.”[4].

Still don’t like these opinions?  Try this: autonomous vehicles may reduce driver liability and the need for auto insurance . . . but that risk and damage will move to products liability and related lines of insurance coverage.

So maybe you can more efficiently distribute participation, ownership, and governance though a blockchain based application . .  . you may also do the same thing with liability and responsibility for damage.  The liability isn’t destroyed: it goes somewhere, or a new kind of liability or damage created.[5]

Of course a physical law may be more absolute than a legal or risk management principle.  So there may be a limit to my analogy.  Still, if you think you’ve engineered risk out of your innovative blockchain application, ask yourself this:  where did it go?  Maybe it’s gone for good, in which case, congratulations! But before celebrating, it maybe wise to recall the first law of lawmodynamics and check under your chair one last time.

** Disclaimer: these are my personal opinions only and may not be shared by past, present or future clients, or any law firm with which I’m affiliated.  And while I happen to be a lawyer, none of this should be seen as legal advice or expression of a legal opinion.  Don’t take legal advice from blog posts or tweets!

[1]. I certainly did not enjoy being right. This had a direct role in causing a wonderful and nearly century old law firm that I was a part of to collapse.

[2].  http://www.livescience.com/50881-first-law-thermodynamics.html.

[3].  http://motherboard.vice.com/read/a-federal-judge-compared-uber-to-silk-road.  (A copy of the opinion is embedded in the article).

[4].http://www.leagle.com/decision/In%20FDCO%2020140710C65/U.S.%20v.%20ULBRICHT


[5].  See, e.g., https://blogs.mcafee.com/mcafee-labs/blockchain-transactions-create-risks-financial-services/; http://www.rmmagazine.com/2016/03/01/the-risks-and-rewards-of-blockchain-technology/.


, the author of this post, is a lawyer focused on Construction, Insurance, and Compliance Driven Software Development. @palleylaw