‘Splitchain’: What is it, and why should lawyers care?

10 May 2022 By Jerome Doraisamy
Lisa Fitzgerald

Given the endless and oft-overwhelming possibilities presented by the current digital age, a better understanding of the intersection between blockchain and the law is needed. Enter, “splitchain”.

The advent of blockchain (that is, digital ledgers of transactions) has inspired new forms of commerce, is widely acceptable, performs “immutable” transactions and can be deployed across various sectors for myriad uses.

However, Lander & Rogers blockchain and digital assets partner Lisa Fitzgerald (pictured) noted that there are blind spots – or misconceptions – with its use.

One such blind spot, she told Lawyers Weekly, is that blockchain acts as a self-contained set of rules that sit above the law.

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“In reality, both on-chain rules (blockchain) and off-chain rules (laws and liabilities) apply,” she said.

This is where splitchain – a term Ms Fitzgerald coined, which refers to a conceptual tool to help clarify blockchain’s interaction with existing legal obligations – becomes key.

“The acceleration of blockchain technology is outpacing the law, [and] as such, robust ‘off-chain’ legal structures are needed to govern the ‘on-chain’ environment,” she explained.

“Looking at the ‘chained economy’ through a dual lens, as two separate strands ─ technological and legal ─ working together in parallel like a double helix is captured in the new concept, splitchain.”

Why lawyers should pay attention to this concept

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The aim of splitchain, Ms Fitzgerald advised Lawyers Weekly, is to clearly illustrate how blockchain technology fits in within our existing legal structures.

“Seeing a strand of blockchain and a strand of legal rights and obligations, working in parallel, is essential to being able to advise on blockchain and assist clients with its commercialisation,” she said.

“One side of this ‘double helix’ represents internal technology-based rules and the other represents external legal rules; one is written in computer code, the other is written in the language of the law; one is on-chain, the other is off-chain, or a hybrid of on- and off-chain.”

Smart contracts, smart legal contacts and IP, Ms Fitzgerald identified, are great examples of splitchain in action.

“If both sides of the blockchain-legal double helix are not considered, significant risks start to emerge. For example, if assignment of intellectual property rights from one party to another is intended, it cannot be achieved via blockchain alone,” she said.

In the context of non-fungible tokens (NFTs), Ms Fitzgerald said there are pertinent questions that a splitchain analysis can ask.

These include, she listed, “what value does a record of tokenisation on blockchain represent? Does the token link to terms that explain its value? Does this make it a security or a derivative and so regulated? Is transfer of ‘ownership’ possible on blockchain?”

“In the case of creative NFTs and intellectual property rights, does ownership of a token translate to actual ownership of a digital artwork or sports moment’? Have any licence terms to use underlying digital artworks, or consumer law rights, been implied in the transaction? What if the server where the artwork is stored goes down or the file is deleted along with the online terms? Is there a contract? Is anything enforceable? Against whom?”

Steps to be taken

Splitchain, Ms Fitzgerald continued, helps distinguish between a variety of blockchain-based transactions.

By forcing us to look for all strands that make an enforceable legal transaction, she said, professionals can start to see that “blockchain technology alone is not the end game”.

“For example, smart contracts (i.e., blockchain-only transactions, despite the name) are not legal contracts. They are automated technology-driven transactions based on a set of rules, but they are not legally enforceable rules that provide participants with rights and remedies. They are technology-based rules. In the absence of clarity around the contracting parties, consideration, intention to create legal relations, certainty of terms, there is no contract formation,” she detailed.

“Smart legal contracts are legally enforceable contracts that rarely exist on-chain only. They attempt to blend the strengths of both on-chain and off-chain environments, leaving contractual clauses that involve human discretion to written format and clauses represented by calculations and formulas to be automated by code. However, smart legal contracts do not encapsulate all legal issues, and it is important that the technological and legal ‘strands’ of the splitchain be considered simultaneously, including contractual rights, and other sources of legal obligations, such as implied rights.”

In IP, Ms Fitzgerald went on, there is a common misconception that rights don’t matter in the digital sphere, or metaverse, because ownership on the blockchain is supposedly foolproof.

“Looking at the nascent NFT market, clear or express terms and conditions are actually a rarity. Where terms do exist, there may be no certainty as to where they are located. At times, terms and conditions may be stored on a creator’s website, at other times, not,” she said.

“This raises the question, without a clear statement of what is being agreed and by whom, whether there is even a contract? One looming question in the creative NFT market is who is liable for potential IP infringement claims as a result of minting someone else’s creative, IP-protected work?”

All of these examples ─ smart contracts, smart legal contracts and IP ─ illustrate splitchain’s purpose, Ms Fitzgerald posited.

That is, “in order for ‘on-chain’ technologies to succeed in the world of commerce, comprehensive ‘off-chain’ governance and legal structures are needed”.

How clients will benefit

When asked what best practice will look like for collaboration between firms and their clients, Ms Fitzgerald said that splitchain would help in-house teams to expose any blind spots in the blockchain-based initiatives of their organisations.

However, she added, specialist analysis may be required from private practitioners to “help adequately address identified concerns or to help re-structure the initiative”.

“Specialist input from technology lawyers, privacy lawyers, financial services lawyers, and/or IP lawyers will be invaluable to this process,” she suggested.

Excitement on the horizon

Reflecting on the future of legal service delivery, Ms Fitzgerald proclaimed that we are “living during the most exciting technological age”.

“The possibilities are endless, but can also be overwhelming. Splitchain is an example of how we, as lawyers, can help simplify and explain to clients something that is conceptually complex and technology-based,” she mused.

“You don’t need to code to understand how to commercialise blockchain in a legally effective way. Often the ‘new’ is something we fear or is relegated to niche’. However, given the ubiquity of technology, and how fundamental it is to doing business, lawyers need to be comfortable and expert in emerging areas of commerce such as blockchain.”

“Splitchain helps lawyers to see and solve blockchain blind spots,” she surmised. 

‘Splitchain’: What is it, and why should lawyers care?
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