DECENTRALIZED PUBLIC LEDGER SYSTEMS AND SECURITIES LAW: NEW APPLICATIONS OF BLOCKCHAIN TECHNOLOGY AND THE REVITALIZATION OF SECTIONS 11 AND 12(A) (2) OF THE SECURITIES ACT OF 1933.

• Author: Bolin, Kelsey

Introduction

When Bitcoin launched in 2009, (1) it was the first virtual cryptocurrency to gain popularity and attain widespread use. (2) Much attention has been paid to Bitcoin's well-publicized advances and setbacks as the world's foremost virtual currency. (3) Less attention has been paid, however, to the decentralized public ledger technology that enables Bitcoin to function. (4) That technology is just as innovative as Bitcoin itself. (5) Decentralized public ledgers are a revolution in digital data storage and have the "potential to fundamentally shift the way in which society operates." (6)

This Note will examine one such societal shift--a change in how shareholders access and assert their rights the securities markets. Specifically, this Note proposes that decentralized public securities ledgers will enable private shareholders to more fully access the protections of Sections 11 and 12(a)(2) of the Securities Act of 1933 in cases of securities fraud.

To facilitate understanding of this new technology, Section I describes the history and function of decentralized public ledger networks. It provides an overview of common ledger formats, and details current and future applications of the technology.

Section II examines how decentralized public ledgers relate to the securities markets at both the national and state levels. It details how the Securities and Exchange Commission ("SEC") plans to implement and regulate the use of decentralized public ledgers and explains how Delaware is currently using the technology to create new classes of corporate stock.

Lastly, Section III of this Note posits that applying decentralized public ledger technology to securities transactions will increase the number of plaintiffs who are capable of achieving standing under Sections 11 and 12(a)(2) of the Securities Act of 1933 (the "Securities Act"). After detailing the history of Section 11, Section 12(a)(2), and the tracing doctrine, Section III explains how decentralized public securities ledgers will transform the tracing doctrine from a nigh-insurmountable pleading burden to a simple records search. It will help a wider scope of plaintiffs meet the judicially- imposed tracing doctrine. Although making this burden easier to fulfill will expand the potential plaintiff pool, and thus may create logistical issues for courts and defendants, the internal structure and pleading requirements of the Securities Act will effectively limit frivolous suits. This, in turn, will better fulfill the statutory language and remedial intent of Sections 11 and 12(a)(2) of the Securities Act.

1. DECENTRALIZED PUBLIC LEDGER SYSTEMS: A HISTORY OF CRYPTOGRAPHIC INNOVATION AND APPLICATION

   Decentralized public ledgers merge traditional record-keeping methods with technological advances to create a new system for preserving and sharing data. (7) Because decentralized public ledgers are a relatively new innovation, Part I of this Note traces their development and explains core features of the technology. It then explores the different formats that digital ledgers can take. Part I concludes by examining current and future applications of decentralized public ledger technology--including how decentralized ledgers facilitate the use of digital currencies, smart contracts, and financial transactions.

   1. The Development and Function of Decentralized Public Ledgers

      Decentralized public ledgers are the technological synthesis of over twenty years of advancements in cryptographic algorithms and computer networking. (8) Prior to these advancements, it was impossible for disparate individuals to agree that an Internet transaction was valid without a trusted centralized authority present to verify the transaction. (9) For example, an Internet user could not digitally transfer money to another user without an intermediary to confirm that the money being transferred actually existed in the quantities and format represented. (10) It is because of this problem, known in computer science circles as the "Byzantine Generals Problem," (11) that services such as PayPal were invented. (12) PayPal and other transactional management services perform an intermediary role by evaluating and confirming the validity of online transactions. (11)

      Decentralized public ledgers, however, enable secure Internet transactions and data storage without the need for a third-party authority to monitor and confirm validity. (14) They allow unrelated groups of people to independently form a consensus regarding the validity of a transaction. (15) Transactions performed via decentralized public ledgers are thus often called "trustless," because they do not require participants to trust in each other, or to trust in a third-party intermediary, for an exchange to take place. (16)

      Decentralized public ledgers enable trustless transactions because of three key features: decentralized consensus mechanisms, distributed data storage, and cryptographic algorithms. (17)

      Decentralized consensus mechanisms are a technological advance that enable trustless consensus as to the validity of a transaction. (18) These mechanisms have different forms, depending on the digital structure of the decentralized ledger, but they all function in the same basic manner. (19) Before a transaction or piece of data can be digitally stored in the decentralized public ledger, the ledger's members must come to a consensus regarding the transaction or data's validity. (20) In this manner, the ledger members supplant a centralized authority that can confirm transactions. (21) Rather than having a service such as PayPal validate a transaction, the members themselves vouch for its legitimacy. (22) Once a transaction reaches consensus, it is permanently stored in the ledger. (23)

      Data storage is thus the next key innovation in decentralized public ledgers. (24) When a transaction requires a trusted central authority for its validation, the authority is the only entity that maintains a complete record of the transaction. (25) For instance, PayPal's individual users cannot each access a full record of all confirmed PayPal transactions. (26) Rather, PayPal itself has that information stored on its own server. (27) The network of PayPal users, and the data accompanying their online transactions, thus constitute a centralized network. (28) Without PayPal's central storage, maintenance, and protection of the complete transactional records on its internal servers, the network would be unable to function. (29)

      Decentralized public ledgers, in contrast, gain their name from a decentralized network structures. (30) When ledger members reach a consensus as to the validity of a transaction, that transaction is stored in each member's copy of the ledger, which is saved on each member's individual computer. (31) Each member of the ledger thus retains a complete record of all ledger transactions at all times, rather than trusting the record to a single centralized authority. (32)

      The decentralized nature of public ledger networks supports the third key feature of the ledgers: cryptographic algorithms. (33) Decentralized public ledgers utilize a "probabilistic approach" to protect their data. (34) When information travels over a decentralized network and can only be stored via group consensus, the information becomes more "transparent and verifiable." (35) Potential attackers attempting to flood a ledger with false information, either by entering completely falsified data or by entering valid transactions multiple times, are blocked from doing so. Such actions are unlikely to gain consensus across the network. (36) Further, unlike ledger data stored in centralized networks, a decentralized public ledger's data cannot be altered merely by gaining access to the network or server. (37) As a decentralized public ledger is independently stored on the computers of everyone involved in the ledger, hacking or tampering with one member's ledger will merely create an inconsistency that can be easily exposed and resolved by comparing it to the ledgers of other members. (38) As yet another layer of protection, ledger networks are frequently protected by innovative defense algorithms. (39)

      These three key features of decentralized public ledgers--decentralized consensus mechanisms, distributed data storage, and cryptographic algorithms--are a true revolution in computer technology. (40) Decentralized public ledgers "enable [disparate] 'people to agree on a particular state of affairs and record that agreement in a secure and verifiable manner'" for the first time in technological history. (41) The result is an online list of transactions that is public, permanent, trustless, (42) and resistant to fraud or error because it is "maintained by no one ... available to everyone ... [and] maintained by a consensus protocol." (43)

   2. Decentralized Public Ledger Formats

      Although decentralized public ledgers share basic structural characteristics, those characteristics can be organized in a variety of formats. (44) Most notably, the form of consensus protocol varies depending on the design given to the decentralized ledger by its programmers and users. (45) The ultimate purpose of the ledger, whether it is to record currency transactions, administer contract agreements, or document financial transactions, also influences its format. (46)

      Bitcoin's "blockchain" is currently the most popular format for a distributed ledger system. (47) The blockchain is a computer network that encrypts each incoming ledger transaction and aggregates it into a group of similarly-timed transactions, termed a "block." (48) Each block serves as a data storage container that connects in chronological order to the previous block in the transactional chain. (49) A new block can only connect to the transactional chain after ledger users reach consensus as to the block's validity. (50)

      Bitcoin's blockchain uses a proof-of-work consensus model to verify its transactions. A...