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How blockchain could be used to make trusts more transparent

David Cameron’s shares in an offshore fund were kept secret

Robert Herian, The Open University

Amid the outcry over David Cameron’s tax affairs is the UK prime minister’s intervention in 2013 to block EU transparency rules regarding offshore trusts. It was decided that trusts should not be held to the same standards as companies when it came to making the end owners and beneficiaries publicly known.

But now the Panama Papers raise important questions as to whether trusts ought to be more open to public scrutiny. A major reason for this relates to fairness when it comes to paying taxes. Blockchain may provide a solution to this problem, enabling trusts to be more transparent, while ensuring the security of their holdings, too.

Trusts are often highly complex legal arrangements; but they tend to work on the same fundamental basis. First conceived many hundreds of years ago, trusts provide a unique method of property management. This uniqueness relates to how wealth is used, and relies on the separation of beneficial ownership from the responsibilities of property management that come with holding legal title.

Trusts come in both public and private forms. But their history points to an intimate desire for individuals and families to be able to preserve their wealth and, importantly, pass it on to the next generation.

One popular story of how trusts came into being involved the Crusaders of the 11th and 12th centuries who, before leaving to fight in the Middle East, arranged for their land to be tended and managed by a friend in trust (a trustee), on behalf of their family (as beneficiaries). This method of property management and transfer had not previously been recognised by Common Law, which viewed the friend as taking the land absolutely when given charge of it. But Equity, at the time a separate body of law in England and Wales, saw things differently.

Based on fairness, Equity developed rules that protected the beneficial interest of the family, while at the same time applying strict fiduciary duties and obligations of trust and loyalty to the friend. This meant that the friend had to look after the property as they had been directed to by the Crusader.

Trusts now appear in the form of international commercial investment and trade vehicles; public and private pension funds; and charities, to name but three of the more economically significant. Yet those same foundations and consensual principles between the Crusader, the friend and the family fundamentally remain.

This means that trusts conform to traditional privacy models found elsewhere in banking and finance, insofar as they shield from public view the identities of the objects of the trust, as well as the nature of many of the trust’s investments and transactions. It is primarily in regard to where this “shield” is positioned that greater levels of transparency apply on the blockchain.

Smart contracts

As part of some recent research, I have been considering how blockchain technology (most famous for its role in the cryptocurrency Bitcoin) and other legal-like processes that blockchain facilitates, namely computer programs called “smart contracts”, might be mapped onto trusts law and trusteeship.

The key to the question of whether or not blockchain can make trusts more open to the public lies in its fundamental characteristics. Blockchain is essentially a peer-to-peer, distributed ledger system that is able to register information in an immutable way. This could take the form of a register of legal titles to property and beneficial interests, both of which are central to trusts.

In this sense, blockchain is a highly reliable witness regarding the information it deals with. Furthermore, as part of the process of adding or registering information on blockchain, that information is announced publicly, providing an entire, transparent history capable of public scrutiny. This does not mean that the blockchain is not private – cultural as well as commercial sensitivity around the privacy of financial information can still be maintained – but it is achieved in a different way.

Using two sets of encrypted keys, one public and one private, to validate transactions provides the possibility for secure, private spaces that nevertheless remain in public view. Unlike other methods that maintain privacy of investments and transactions by shielding the entire process from public view, including the identities of individual parties, the blockchain breaks the flow of information in another place: by keeping public keys anonymous.

So a trust could take the form of a “private space”. More specifically what is legally defined as a trust could be mapped onto the blockchain processes behind that “private space”. This would create, what I call a “smart trust” – a secure private space, yet one primed for public scrutiny.

The potential of the blockchain as described here is something of a “third-way” to existing privacy models. Because trusts come in many shapes and sizes, blockchain “smart trusts” would undeniably suit some types more than others – it is not a case of one size fits all. While trusts have a very long history, the blockchain has a very short one. It will take time to understand if and how the two might work together. But if greater levels of honesty and transparency are needed, the blockchain could provide an answer.

The Conversation

Robert Herian, Lecturer in Law, The Open University

This article was originally published on The Conversation. Read the original article.