GUEST BLOG: Acts of Code by Aegis Frumento Esq

May 2, 2019

Acts of Code

by Aegis J. Frumento, Partner, Stern Tannenbaum & Bell

One concept redolent in Taoism, that ultimately found its way into Zen, is doing-by-not-doing. The Tao Te Ching tells that the master acts without acting, so that his followers think they do things all by themselves. Eugene Herrigel recounts in Zen in the Art of Archery his several years learning to shoot an arrow under the tutelage of a Zen master. Success only came when his arrow shot "itself." George Lucas picked up the idea to create the Force that binds the Star Wars universe together. Similarly, pre-modern Europeans believed in angels, witches and fairies, and the so-called primitive religions believe in nature spirits. What they all have in common is a serene acceptance that we don't control much.

We so-called Moderns aren't comfortable with that. We want human agency, which is a fancy way to say we want control. We cringe at the thought that shit just happens.

So, we've come up with many ways to express our discomfort with irrational causes. In 1987, George Leonard wrote an influential piece in Esquire about mastery, in sports and life. The master keeps working at his or her skill until the required movements become second nature. Then, in the heat of the action, the bat seems to know by itself where and when to meet the pitch, and the basketball finds its own arc to the hoop. More recently, psychologists have labeled the phenomenon "Flow." Being in Flow, one is so attentively focused on the task at hand that time seems to stand still. Now that attentiveness is itself being called "mindfulness."

A Zen master might call such episodes moments of "enlightenment,' and the effort to get there a meditation. East, West, primitive or modern, it's all the same, because we are all the same. The difference is that we in the West demand credit for our performances. But then, when something goes wrong, everyone wants to stick us with the blame. So ingrained is this notion of personal agency that we feel quite lost when we cannot hold someone responsible for bad things happening. Legally, in theory, every event that causes an injury can be laid at someone's door. The usual exceptions are lumped into a category called "Acts of God" -- things like earthquakes, tsunamis, forest fires, meteor strikes and other phenomenon for which (global warming aside) we can't find any human to sue.

When SEC Chairman Jay Clayton notes that one of the SEC's goals in regulating securities is to ensure someone can always be held responsible for screw-ups, he is reflecting this deep instinct. Recall that in his discussion with Andrew Ross Sorkin last year, a member of the audience confronted Clayton with a question - why does a cryptosecurity, which is only transferable on a blockchain, need a transfer agent? His answer, basically, was because we need to blame someone for an illegal transfer. See That answer was fully consistent with modern ideas of human responsibility, but it betrayed a deep ignorance of how blockchain-enabled securities actually work. Until we do a better job reconciling the reality of blockchain technology with our traditional notions of human agency, we won't achieve a coherent theory of how to regulate cryptosecurities.

Last month, the fledgling fintech company Templum Inc., in a rule-making petition to the SEC, raised a similar metaphysical question: Do cryptosecurity "miners" need to be broker-dealers? Templum's analysis is quite good, even though inconclusive, which is why it well illustrates the pitfalls of applying traditional securities law logic to cryptosecurities. 

The flaw is that Templum picked up the SEC's own misunderstanding of mining in the one short paragraph devoted to describing it. The SEC described mining as "applying computer power to try to solve complex equations that verify a group of transactions in that virtual currency," where "[t]he first computer . . . to solve such an equation is awarded new units of that virtual currency." That is gobbledy-gook. It doesn't tell you what miners actually do, and without understanding what mining really is, one cannot craft a sensible legal framework for them.

One of the better introductions to the crypto field, Bitcoin and Cryptocurrency Technology, by Arvind Narayanin and 4 co-authors, describes mining as a 6-step process, only one of which involves verifying any transactions: 

1. A miner, acquires a copy of the most recently extended blockchain ledger and receives transactions that are broadcast to the network by blockchain users. 

2. The miner then verifies that the transactions are properly signed by those effecting them. 

3. Once the miner has collected a set of verified transactions large enough to assemble into a block meeting the blockchain's parameters, it creates a block as its candidate to be appended to the blockchain. That candidate block will include a special transaction awarding the miner a certain number of cryptosecurities as its potential reward. 

4. Then it's off to the races. The miner applies various random numbers (called "nonces") to the block it just created (here it gets mathematically complicated) until it gets a cryptographic result that permits the block to be appended to the last block already in the chain.

5. Once the miner finds the solution, it publishes it to the rest of the mining community. 

6. Meanwhile, the entire community of miners is simultaneously trying to append their own candidate blocks, containing some or all of the same transactions, to the chain. If 51% of the mining community accepts our miner's block, it gets added to the chain. Since that block contains a transaction issuing coins to the miner, that's how and when the miner gets paid. And then it's on to the next set of transactions not already included in the latest block.

So, are miners broker-dealers? If you start with a supposition that miners get paid for facilitating securities transactions, as Templum did, then the answer leans toward "yes." But that's not what miners do in real life. If you look at what miners really do, it is hard to see the work of a broker-dealer in any of it. Miners maintain the blockchain by engaging a what can only be called a ritual. The result of that ritual is sometimes a reward, but most times nothing. To call them "miners" is a misnomer. Shaman is more apt.

This illustrates why we may need a new legal category to deal with crytposecurities. The SEC is focused on holding some person responsible for screw-ups in an environment designed to operate without any human influence. If a piece of software is miscoded, intentionally or carelessly, then the coder should be liable for that, through some kind of coders malpractice. But if a piece of software misbehaves on its own, then really, who can you sue? It is simply not fair to name an artificial fall guy -- a transfer agent that doesn't transfer anything, or a similarly impotent clearing firm or custody agent -- just so we can vent our wrath on a human being. When dealing with blockchain transactions, malfunctions not caused by miscoding are, if not Acts of God, then maybe Acts of Code. And, like Acts of God, Acts of Code should be dealt with not by flailing a scapegoat, but by spreading the risk to the community through some kind of insurance.

This issue isn't limited to cryptosecurities. As more of our lives become automated, and as machine learning evolves to more and more sophisticated AI applications, we will increasingly have to come to terms with events for which no human can be held responsible. Don't bemoan it -- life would really be a lot simpler and saner if we gave up trying to get credit and avoid blame for much of what happens. Our impact on the world is rarely what we crack it up to be, and that too is a comforting thought.


Aegis J. Frumento
Stern Tannenbaum & Bell
Co-Head, Financial Markets Practice

380 Lexington Avenue
New York, NY 10168

Aegis Frumento is a partner of Stern Tannenbaum & Bell, and co-heads the firm's Financial Markets Practice. Mr. Frumento represents persons and businesses in all aspects of commercial, corporate and securities matters and dispute resolution (including trials and arbitrations); SEC and FINRA regulated firms and persons on regulatory compliance issues and in SEC and FINRA enforcement investigations and proceedings; and senior executives of public corporations personal securities law and corporate governance matters.  Mr. Frumento also represents clients in forming and registering broker-dealers and registered investment advisers, in developing compliance policies, procedures and controls, and in adopting proper disclosure documents. Those now include industry professionals looking to adapt blockchain technologies to finance and financial market enterprises.

Prior to joining the firm, Mr. Frumento was a managing director of Citigroup and Morgan Stanley, a partner and the head of the financial markets group of Duane Morris LLP, and the managing partner of Singer Frumento LLP.

He graduated from Harvard College in 1976 and New York University School of Law in 1979. Mr. Frumento is a frequent author and speaker on securities law issues, and is often quoted in the media on current securities law developments.

NOTE: The views expressed in this Guest Blog are those of the author and do not necessarily reflect those of Blog.