Analysis: Court Ordered Code - The Implications of a Forced Fork
- Only time will tell if a class action suit demanding a fork of the Nano blockchain was a smart move
The Bitgrail / Nano / XRB saga, however, presents us with such an opportunity.
The saga involves a cryptocurrency called XRB, which comes from a blockchain called Nano. Nano developers are based in the US. The white paper for XRB was published in late 2014. According to sources and reports, most of the XRB issued was exchanged and traded on Bitgrail, an Italy-based cryptocurrency exchange.
In February 2018, $170 million worth of XRB tokens were stolen from BitGrail. BitGrail and Nano have been publicly blaming each other for the hack, as can be seen in the social media accounts of both Nano developers and Francesco "the bomber" Firano, the operator of Bitgrail.
The latest twist in the saga is highly interesting. One of the account holders of the stolen XRB decided to take legal action in the form of submitting a class action suit against Nano. The plaintiff is asking the court to order a ‘rescue fork’ in Nano's blockchain. Such a step would allow the issuance of new XRB tokens, which would then be distributed to all account holders as a substitute to the stolen XRB tokens.
When does a fork occur?
A fork occurs when a single blockchain is split in two for one of two reasons:
1) A split in consensus or - since bitcoin is a distributed and decentralized network - a fork occurs when miners discover a block at the same time, resulting in two split chains. However, this is only a temporary fork, as the chain that finds the next block first becomes the longest chain and automatically becomes the ‘true’ chain. Therefore, the shorter chain will be abandoned by the network.
2) A change in the underlying rules of the protocol. This represents a conscious change of the underlying codes by developers and is permanent. The reason for changing the code base can be due to either adding new features to enhance the network's functionalities or by changing a core rule, such as increasing the block size.
A change in the underlying rules of the protocol can be classified as either a soft fork or a hard fork. A soft fork is a software upgrade that is backwards compatible with older versions. This means that participants who did not upgrade to the new software will still be able to participate in validating and verifying transactions.
A hard fork refers to a software upgrade which is not compatible with older versions. That means that all participants will need to upgrade to the new software if they want to continue to participate in validating and verifying transactions. Otherwise, they will be separated from the network. This creates a divergence in the blockchain.
The plaintiff in the XRB case argues that ‘forking’ is the best legal relief available. Needless to say, this legal claim is a novelty in the crypto space. While we await the court's ruling, let us share some thoughts on the matter.
The need for Regulation Regulation Like any other industry with a high net worth, the financial services industry is tightly regulated to help curb illicit behavior and manipulation. Each asset class has its own set of protocols put in place to combat their respective forms of abuse.In the foreign exchange space, regulation is assumed by authorities in multiple jurisdictions, though ultimately lacking a binding international order. Who are the Industry’s Leading Regulators?Regulators such as the UK’s Financial Conduct Authority (FCA), the US’ Securities and Exchange Commission (SEC), Australian Security and Investment Commission (ASIC), and the Cyprus Securities and Exchange Commission (CySEC) are the most widely dealt with authorities in the FX industry.In its most basic sense, regulators help ensure the filing of reports and transmission of data to help police and monitor activity by brokers. Regulators also serve as a countermeasure against market abuse and malpractice by brokers. Brokers adhering to a list of mandated rules are authorized to provide investment activities in a given jurisdiction. By extension, many unauthorized or unregulated entities will also seek to market their services illegally or function as a clone of a regulated operation.Regulators are essential in snuffing out these scam operations as they prevent significant risks for investors.In terms of reporting, brokers are also required to regularly file reports about their clients’ positions to the relevant regulatory authorities. The most-recent regulatory push in the aftermath of the Great Financial Crisis of 2008 has delivered a material shift in the regulatory reporting landscape.Brokers typically outsource the reporting to other companies which are connecting the trade repositories used by regulators to the broker’s systems and are handling this crucial element of compliance.Beyond FX, regulators help reconcile all matters of oversight and are watchdogs for each industry. With ever-changing information and protocols, regulators are always working to promote fairer and more transparent business practices from brokers or exchanges. Like any other industry with a high net worth, the financial services industry is tightly regulated to help curb illicit behavior and manipulation. Each asset class has its own set of protocols put in place to combat their respective forms of abuse.In the foreign exchange space, regulation is assumed by authorities in multiple jurisdictions, though ultimately lacking a binding international order. Who are the Industry’s Leading Regulators?Regulators such as the UK’s Financial Conduct Authority (FCA), the US’ Securities and Exchange Commission (SEC), Australian Security and Investment Commission (ASIC), and the Cyprus Securities and Exchange Commission (CySEC) are the most widely dealt with authorities in the FX industry.In its most basic sense, regulators help ensure the filing of reports and transmission of data to help police and monitor activity by brokers. Regulators also serve as a countermeasure against market abuse and malpractice by brokers. Brokers adhering to a list of mandated rules are authorized to provide investment activities in a given jurisdiction. By extension, many unauthorized or unregulated entities will also seek to market their services illegally or function as a clone of a regulated operation.Regulators are essential in snuffing out these scam operations as they prevent significant risks for investors.In terms of reporting, brokers are also required to regularly file reports about their clients’ positions to the relevant regulatory authorities. The most-recent regulatory push in the aftermath of the Great Financial Crisis of 2008 has delivered a material shift in the regulatory reporting landscape.Brokers typically outsource the reporting to other companies which are connecting the trade repositories used by regulators to the broker’s systems and are handling this crucial element of compliance.Beyond FX, regulators help reconcile all matters of oversight and are watchdogs for each industry. With ever-changing information and protocols, regulators are always working to promote fairer and more transparent business practices from brokers or exchanges. Read this Term
We cannot escape the thought that all responsibility is put on the account of Nano while evading the discussion about the exchange's responsibility. The fact the exchange is based outside of the US (Italy) must have played a role as to whom to sue. In this case, it also highlights the urgent need for regulations to be applied on crypto exchanges.
The focus on ICOs and the analysis of whether tokens are securities or not have taken us away from the fact that most crypto exchanges, including some of the major players in the crypto space, are unregulated.
The underlying rationale behind the rescue forking relief is that it is the relatively easiest thing to do. We can assume that in regards to direct costs, changing the underlying rules of the Nano protocol is likely to be cheaper than reimbursing $170 million worth of XRB tokens. But we need to consider the broader picture.
As a start, XRB holders who were not affected by the Bitgrail hack may argue that a fork may have a negative impact on them, especially because the class action suit does not state which kind of fork will be sought – soft or hard. In case of a soft fork, non-affected holders of XRB may argue that if they are to remain in the original, non-upgraded version of Nano, their functionality is likely to be affected as this is typically the case in a soft fork.
For that reason, it is likely that the forking to be sought will be a hard fork, either in the form of a contentious hard fork or in the form of spin-off coins (as was the case with Litecoin).
Another important point is the applicability of securities laws. One of the cornerstone arguments in the class action suit is that XRB tokens are investment contracts which should have been registered as securities. Let us set aside the legal analysis of the Howey test as presented in the claim, which is far from being exemplary; the mere involvement of the securities laws and potentially the SEC is likely to have a major impact and more of a revolving sword.
It is likely that the SEC will examine whether XRB tokens are securities. Should the SEC conclude that this was the case, Nano will be facing potential federal charges. On top of that, if XRB tokens are securities, what is the likelihood of the new tokens to be issued after the rescue fork not being securities? That means the fork is likely to result in a lengthy and expensive securities registration and offering process.
The plaintiff may have been better arguing other civil claims without involving securities. Time will tell if that should have been their initial strategy.
The Bitgrail / Nano / XRB saga, however, presents us with such an opportunity.
The saga involves a cryptocurrency called XRB, which comes from a blockchain called Nano. Nano developers are based in the US. The white paper for XRB was published in late 2014. According to sources and reports, most of the XRB issued was exchanged and traded on Bitgrail, an Italy-based cryptocurrency exchange.
In February 2018, $170 million worth of XRB tokens were stolen from BitGrail. BitGrail and Nano have been publicly blaming each other for the hack, as can be seen in the social media accounts of both Nano developers and Francesco "the bomber" Firano, the operator of Bitgrail.
The latest twist in the saga is highly interesting. One of the account holders of the stolen XRB decided to take legal action in the form of submitting a class action suit against Nano. The plaintiff is asking the court to order a ‘rescue fork’ in Nano's blockchain. Such a step would allow the issuance of new XRB tokens, which would then be distributed to all account holders as a substitute to the stolen XRB tokens.
When does a fork occur?
A fork occurs when a single blockchain is split in two for one of two reasons:
1) A split in consensus or - since bitcoin is a distributed and decentralized network - a fork occurs when miners discover a block at the same time, resulting in two split chains. However, this is only a temporary fork, as the chain that finds the next block first becomes the longest chain and automatically becomes the ‘true’ chain. Therefore, the shorter chain will be abandoned by the network.
2) A change in the underlying rules of the protocol. This represents a conscious change of the underlying codes by developers and is permanent. The reason for changing the code base can be due to either adding new features to enhance the network's functionalities or by changing a core rule, such as increasing the block size.
A change in the underlying rules of the protocol can be classified as either a soft fork or a hard fork. A soft fork is a software upgrade that is backwards compatible with older versions. This means that participants who did not upgrade to the new software will still be able to participate in validating and verifying transactions.
A hard fork refers to a software upgrade which is not compatible with older versions. That means that all participants will need to upgrade to the new software if they want to continue to participate in validating and verifying transactions. Otherwise, they will be separated from the network. This creates a divergence in the blockchain.
The plaintiff in the XRB case argues that ‘forking’ is the best legal relief available. Needless to say, this legal claim is a novelty in the crypto space. While we await the court's ruling, let us share some thoughts on the matter.
The need for Regulation Regulation Like any other industry with a high net worth, the financial services industry is tightly regulated to help curb illicit behavior and manipulation. Each asset class has its own set of protocols put in place to combat their respective forms of abuse.In the foreign exchange space, regulation is assumed by authorities in multiple jurisdictions, though ultimately lacking a binding international order. Who are the Industry’s Leading Regulators?Regulators such as the UK’s Financial Conduct Authority (FCA), the US’ Securities and Exchange Commission (SEC), Australian Security and Investment Commission (ASIC), and the Cyprus Securities and Exchange Commission (CySEC) are the most widely dealt with authorities in the FX industry.In its most basic sense, regulators help ensure the filing of reports and transmission of data to help police and monitor activity by brokers. Regulators also serve as a countermeasure against market abuse and malpractice by brokers. Brokers adhering to a list of mandated rules are authorized to provide investment activities in a given jurisdiction. By extension, many unauthorized or unregulated entities will also seek to market their services illegally or function as a clone of a regulated operation.Regulators are essential in snuffing out these scam operations as they prevent significant risks for investors.In terms of reporting, brokers are also required to regularly file reports about their clients’ positions to the relevant regulatory authorities. The most-recent regulatory push in the aftermath of the Great Financial Crisis of 2008 has delivered a material shift in the regulatory reporting landscape.Brokers typically outsource the reporting to other companies which are connecting the trade repositories used by regulators to the broker’s systems and are handling this crucial element of compliance.Beyond FX, regulators help reconcile all matters of oversight and are watchdogs for each industry. With ever-changing information and protocols, regulators are always working to promote fairer and more transparent business practices from brokers or exchanges. Like any other industry with a high net worth, the financial services industry is tightly regulated to help curb illicit behavior and manipulation. Each asset class has its own set of protocols put in place to combat their respective forms of abuse.In the foreign exchange space, regulation is assumed by authorities in multiple jurisdictions, though ultimately lacking a binding international order. Who are the Industry’s Leading Regulators?Regulators such as the UK’s Financial Conduct Authority (FCA), the US’ Securities and Exchange Commission (SEC), Australian Security and Investment Commission (ASIC), and the Cyprus Securities and Exchange Commission (CySEC) are the most widely dealt with authorities in the FX industry.In its most basic sense, regulators help ensure the filing of reports and transmission of data to help police and monitor activity by brokers. Regulators also serve as a countermeasure against market abuse and malpractice by brokers. Brokers adhering to a list of mandated rules are authorized to provide investment activities in a given jurisdiction. By extension, many unauthorized or unregulated entities will also seek to market their services illegally or function as a clone of a regulated operation.Regulators are essential in snuffing out these scam operations as they prevent significant risks for investors.In terms of reporting, brokers are also required to regularly file reports about their clients’ positions to the relevant regulatory authorities. The most-recent regulatory push in the aftermath of the Great Financial Crisis of 2008 has delivered a material shift in the regulatory reporting landscape.Brokers typically outsource the reporting to other companies which are connecting the trade repositories used by regulators to the broker’s systems and are handling this crucial element of compliance.Beyond FX, regulators help reconcile all matters of oversight and are watchdogs for each industry. With ever-changing information and protocols, regulators are always working to promote fairer and more transparent business practices from brokers or exchanges. Read this Term
We cannot escape the thought that all responsibility is put on the account of Nano while evading the discussion about the exchange's responsibility. The fact the exchange is based outside of the US (Italy) must have played a role as to whom to sue. In this case, it also highlights the urgent need for regulations to be applied on crypto exchanges.
The focus on ICOs and the analysis of whether tokens are securities or not have taken us away from the fact that most crypto exchanges, including some of the major players in the crypto space, are unregulated.
The underlying rationale behind the rescue forking relief is that it is the relatively easiest thing to do. We can assume that in regards to direct costs, changing the underlying rules of the Nano protocol is likely to be cheaper than reimbursing $170 million worth of XRB tokens. But we need to consider the broader picture.
As a start, XRB holders who were not affected by the Bitgrail hack may argue that a fork may have a negative impact on them, especially because the class action suit does not state which kind of fork will be sought – soft or hard. In case of a soft fork, non-affected holders of XRB may argue that if they are to remain in the original, non-upgraded version of Nano, their functionality is likely to be affected as this is typically the case in a soft fork.
For that reason, it is likely that the forking to be sought will be a hard fork, either in the form of a contentious hard fork or in the form of spin-off coins (as was the case with Litecoin).
Another important point is the applicability of securities laws. One of the cornerstone arguments in the class action suit is that XRB tokens are investment contracts which should have been registered as securities. Let us set aside the legal analysis of the Howey test as presented in the claim, which is far from being exemplary; the mere involvement of the securities laws and potentially the SEC is likely to have a major impact and more of a revolving sword.
It is likely that the SEC will examine whether XRB tokens are securities. Should the SEC conclude that this was the case, Nano will be facing potential federal charges. On top of that, if XRB tokens are securities, what is the likelihood of the new tokens to be issued after the rescue fork not being securities? That means the fork is likely to result in a lengthy and expensive securities registration and offering process.
The plaintiff may have been better arguing other civil claims without involving securities. Time will tell if that should have been their initial strategy.