Author: Luis Blanquez
Blockchain is an emerging technology that is already changing the way companies do business. But this doesn’t precludn companies using such nascent technology frot getting caught in the same old anticompetitive practices subject to the antitrust laws.
Before diving into the spectrum of anticompetitive behavior that companies using blockchain technology might get involved, let’s first explain below what distributed ledger technology (“DLT”) and blockchain mean, and what are––at least for now––the different types of blockchains.
In the last section of this article, we also analyze how antitrust group boycotts could apply in a blockchain-setting. And we provide two real life recent examples, the Bitmain case and the Ethereum Merge.
What Is Blockchain Technology?
A “blockchain” is a decentralized, electronic register in which transactions and interactions can be recorded and validated in a verifiable and permanent way. A peer-to-peer network where different users or “nodes” share and validate information in a database or network without the need of a centralized and trusted intermediary.
Records of transactions are stored along with other transactions into blocks of data that are linked to one another in a chain, creating a blockchain, which is a type of distributed ledger technology (“DLT”). Each ledger is tamper-proof and recorded using a consensus verification algorithm that encoded every prior block in the blockchain. Once a block is added to the chain, it is virtually impossible to modify. Any change would require modifying every subsequent block of data on the chain. And because each participant on the blockchain has a unique identification key, other users can instantly verify prior transactions involving that participant.
Bitcoin is the first and most prominent use of blockchain technology and has several features that distinguish it from other blockchains, including actual digital scarcity with a programmed limit of 21 million Bitcoin, forever.
With the help of Web3, blockchain technology has opened the door for companies across many industries––not just cryptocurrencies––to make more efficient, inexpensive, and secure business transactions without the need for a centralized authority. In other words, this a whole new ballgame.
Types of Blockchains: Permissionless v. Permissioned
There are two main types of blockchains.
Permissionless (public) blockchains are publicly available and fully decentralized DLTs, which means there is no central authority involved. They allow everyone to interact and participate in the validation process because they are based on open-source protocols, providing strong security. Validators must all vote to adopt the protocols and code that become the decision-making process of the blockchain. This makes it very difficult to change the behavior of the blockchain. Transactions are also fully transparent, and the nodes involved are almost always anonymous. They have, however, some technical restraints such as (i) less control over privacy (everyone has access to what is going on in the blockchain); and (ii) lower scalability and level of performance than permissioned blockchains––mainly due to the wide scope of their verification process and the amount of information they need to process.
Permissioned (private and consortium) blockchains are made by a smaller pool of validators who are partially decentralized DLTs. Only few known (as opposed to anonymous) and previously identified parties can access the ledger and participate in the validation process. Participants need permission to have a copy of the ledger. Thus, even though there is no central authority involved, a short group of participants validate and share the data relevant to transactions. This means less transparency and a higher risk of collusion and abuse of market power because only few nodes manage the transaction verification and consensus process. On the flip side, privacy is stronger, and they are more scalable and customizable.
This distinction is important to identify and analyze antitrust issues, depending on the type of blockchain involved. But the more the blockchain technology develops, the more those differences have become blurred. A combination of small permissioned blockchains with more open, wider, and decentralized ones (although sometimes still using encrypted transactions) had become a common trend. Interoperability between blockchains and existing network externalities are both expected to keep verification prices down while increasing security. In the end, the final configuration of a blockchain and its software code will depend on the strategy and business model selected, which is something that needs to be analyzed on a case-by-case basis, considering the industry and applications involved.
The same applies to the enforcement of antitrust laws to this new technology. That’s why it is essential that companies using blockchain technology have a clear antitrust compliance policy in place and train their key employees accordingly. This is particularly important for those involved with the business strategy of the company and the ones interacting on a regular basis with competitors.
Group Boycotts: The Bitmain case and the Ethereum “Merge”
Private blockchain participants may breach antitrust rules if they exclude competitors from the blockchain without a legitimate business justification. Those who control the blockchain may limit potential competitors access to the chain or may not allow them to conduct transactions therein. This is called a group boycott or a concerted refusal to deal—where multiple entities combine to exclude or otherwise inhibit another party. When that “concerted” boycott involves market power or horizontal control over an essential facility or resource, courts typically always analyze it under the “per se” rule.
Thus, if private blockchain participants exclude a competitor from the blockchain, and (i) the DLT is a necessary infrastructure for others to effectively compete, or (ii) its members enjoy market power in the market concerned, they might be subject to antitrust rules unless they can show an objective business justification. That’s why membership rules to permissioned blockchains should always be transparent, objective, reasonable and non-discriminatory. To show that those same participants on the chain did not deny access a potential competitor, but that such competitor did not meet the pre-established standards applied to everyone involved.
Similarly, blockchain participants with market power must also avoid any horizontal collusion with members from other blockchains and non-blockchains when vertically dealing with suppliers upstream or customers downstream. A boycott not to deal with a supplier upstream or a customer downstream, without a legitimate business justification, will also create potential antitrust liability.
So far, we have seen two potential examples of antitrust group boycotts in the blockchain world.
The first example is the Bitmain case, where certain mining pools, protocol developers and crypto-exchange defendants allegedly colluded to manipulate a network upgrade by creating a new hard fork, taking control of the Bitcoin Cash cryptocurrency. In the end, however, the court concluded that the plaintiff ––a protocol developer of blockchain transactions and mining cryptocurrencies––, failed to (i) show a plausible conspiracy, (ii) define any relevant product market to prove an unreasonable restriction of trade, and (iii) show any antitrust injury.
In the case of the group boycott allegations, the Court held that plaintiffs failed the pleading requirements for a per se group boycott claim because, among other things, plaintiffs (i) did not show whether the alleged agreement precluded United American Corporation from mining the two competing software upgrades Bitcoin ABC and Bitcoin SV cryptocurrencies, (ii) did not allege that defendants were horizontal competitors in any relevant antitrust market, and (iii) did not allege that defendants possessed market power in a relevant product or geographic market.
The second example is the recent Ethereum “Merge”. This upgrade has been one of the most commented events in the crypto world and a major experiment in Web3. What this basically means is that in September 2022 the Ethereum blockchain––using the well-known native token ETH––moved from a proof-of-work (PoW) consensus mechanism to a proof-of-stake (PoS) consensus mechanism. If you want to know the main differences between these two mechanisms and how they work, we suggest you read Lesson No. 3: Consensus Mechanisms and the Merge from Around the Blockchain.
Leaving scalability, security and environmental issues aside––although we encourage you to read our article on the environmental benefits of Bitcoin using PoW, contrary to what many believe about the PoS model being more energy beneficial––the key question here is why the existing difference between PoW and PoS consensus mechanism is relevant for antitrust purposes.
Coinbase explains it very well: “Proof-of-work blockchains are secured and verified by virtual miners around the world racing to be the first to solve a math puzzle. The winner gets to update the blockchain with the latest verified transactions and is rewarded by the network with a predetermined amount of crypto.
[On the flipside], in a Proof of stake system, staking serves a similar function to proof of work’s mining, in that it’s the process by which a network participant gets selected to add the latest batch of transactions to the blockchain and earn some crypto in exchange. The exact details vary by project, but in general proof of stake blockchains employ a network of “validators” who contribute—or “stake”—their own crypto in exchange for a chance of getting to validate a new transaction, update the blockchain, and earn a reward.
The network selects a winner based on the amount of crypto each validator has in the pool and the length of time they’ve had it there—literally rewarding the most invested participants. Once the winner has validated the latest block of transactions, other validators can attest that the block is accurate. When a threshold number of attestations have been made, the network updates the blockchain. All participating validators receive a reward in the native cryptocurrency, which is generally distributed by the network in proportion to each validator’s stake”.
In other words, private blockchains are partially decentralized and only previously identified parties can access the ledger and participate in the validation process. They allow for more privacy and scalability, with more dynamic consensus mechanisms to validate transactions, but at the same time, they significantly increase the antitrust risks. For instance, validators might conspire to change the protocol and algorithm of a blockchain to increase prices, limit potential competitors’ access to the chain, or even restrict other blockchains’ ability to compete.
One risk for Ethereum and proof of stake is that because the validation process for a new block is now divorced from actual physics in the real world—the electricity and specialized machinery utilized by proof of work miners—it will likely be easier for some entity or multiple entities to obtain sufficient control of staked Ethereum to affect the chain. Scaling is simpler in a virtual world than the physical world. That is, decentralization is less secure. You can see this already in that cryptocurrency exchanges are controlling a large percentage of staked Ethereum on behalf of their clients. When you have multiple entities controlling large parts of the market, you often begin to see coordination: direct, tacit, and consciously parallel.
We’ll have to see what happens.
Image by Miloslav Hamřík from Pixabay