Ashurst partners Chris Bates and David Futter on the key legal and regulatory issues that will need to be considered before mainstream adoption of blockchain in the energy market can be realised
In spring 2016, a blockchain-powered project in Brooklyn, New York was piloted to enable the residents to buy and sell renewable energy directly to their neighbours. The project, run by a digital start-up called Transactive Grid, aims to disintermediate the central electricity suppliers and network providers through the use of blockchain technology. Participants in the project connect solar PV systems installed on their rooftops to a network of computers, which continuously record the energy generated and trade the excess within the community.
All buildings in the project are interconnected through the conventional power grid, with the energy transactions being managed and stored using a central blockchain. The project uses both smart meter technology and underlying blockchain software: the smart meters record the wattage of energy produced, while the blockchain software executes and records the transactions. All energy is bought and sold without a central energy company being involved; the blockchain platform manages the market autonomously.
The Brooklyn Microgrid project is too nascent for us to assess properly its likely impact on the electricity market. Whether the microgrid concept can evolve beyond merely an interesting local community initiative into something more fundamentally transformative remains to be seen. Nonetheless, there is little doubt that the underlying blockchain technology is capable of heralding serious transformation (or disruption, depending on your viewpoint) to the energy sector as a whole.
So, what is blockchain technology?
At a very high level, blockchain technology describes a collection of software programs that enable identical copies of data to be recorded, maintained and verified across a community of users, enabling them all to agree on the data’s authenticity and veracity. To achieve this, blockchains use decentralised storage platforms to record the data across a peer-to-peer network: each computer within the network can hold a complete copy of the data (i.e. in a ledger) and confirm blocks of new transaction messages that are submitted for entry onto the ledger by other members of the network.
In other words, it is basically a shared database: an enormous spreadsheet that runs simultaneously on thousands — in some cases millions — of computers (known as “nodes”), and which is open source, so that anyone of those nodes can read, check and add to the database.
A blockchain can be permissioned (a private network where all participant nodes are known) or permission-less (a public network where anybody can act as a node). In either case, the validation process typically involves nodes solving state-of-the-art cryptographic problems, using complex algorithmic functions (known as “hashes”). These hashes are used to evidence that each transaction has been authorised by its sender and used to link each block of transactions to each other. So, once a block has been validated by consensus on the network, it is then added indelibly onto the ledger. This is deliberate and serves to shield the blockchain against cyberattack — any hacker would have to control more than half the entire node network to alter any record in the blockchain.
The overall process creates a mutual consensus mechanism through which it is practically impossible to alter any of the past, validated transactions on the ledger.
The first blockchain was developed as the basis of the crypto-currency “bitcoin”. Since then, various iterations of the core blockchain technology have evolved. These iterations deploy additional functionality, including blockchains which are beginning to integrate programmable logic to enable transactions to be effected automatically and consensually across the blockchain community (known as “smart contracts”).
Possible applications for blockchain in the energy sector
Apart from the prospect of decentrally generated energy being sold directly between participants in smart grids like that of the Brooklyn Microgrid, other future applications for blockchain are being envisioned across the energy sector.
Many possible uses, like the ones outlined below, remain at early stage development. But because blockchain technology, particularly through the advance of Smart Contracts, enables transactions to be made directly between individual participants, it is beginning to change the way that energy firms think about their businesses. Much like the disruption experienced by financial services over the last few years, blockchain promises the energy industry opportunities to exploit lower operating costs, faster processing capacity and to create new innovative sell-side business models.
Simplified energy supply ecosystem
A major possible use being explored is to deploy blockchain technology via Smart Contracts to redesign the energy supply value chain. The concept is that by creating decentralised common infrastructures, a future state can be created in which the current complex, multilateral energy value chain can be simplified dramatically. For example, Electron, a London-based energy start-up, is looking to apply blockchain technology to the industry’s asset registration services, to create a distributed shared platform for energy providers to obtain information about particular assets, and also to record any transactional changes to those assets.
Smart energy switching
Blockchain technologies could allow consumers to arbitrage energy rates in near real time, so that rather than paying for their energy needs at a fixed, set rate with a single supplier, they could switch dynamically between multiple providers on an intra-day basis to optimise best price. Such a dynamic purchasing model is possible due to the potential speed and efficiency with which blockchain-based transactions can, in theory, be effected. In their latest Report on Innovation and Regulation, the British gas and electricity markets regulator, Ofgem, continues to identify a strong desire to overhaul the current processes for consumers to switch their energy suppliers, so this type of development is likely to be of keen interest to energy market regulators.
Global energy transfers
Blockchain technology could form the basis of software platforms for “sending” energy, such as electricity or gas, anywhere in the world. These energy transfers could be made via interconnected software applications that are developed on top of a blockchain. The developers of such energy transmission platforms see them competing with the money remittance market; for example, enabling migrant workers to send energy back home in place of cash, or by giving individuals the choice to donate energy to specific charities or even developing nations, with all donations being recorded and verified transparently.
Decentralised storage on a blockchain of all records of renewable energy generated by consumers, communities or businesses could be automatically converted into government-backed digital energy credits. These credits, being a new form of crypto-currency, could in turn be used to purchase commodities, effectively operating as a direct renewable energy incentive.
Key challenges to adoption
While the industry’s recognition of the transformative potential of blockchain continues to grow, there remain considerable areas of risk on which the market and global energy regulators will be keen to focus as the technology and its applications mature.
One of the first hurdles is the lack of technical standardisation. It is unlikely that energy businesses that want to use a blockchain for a particular use will have all of the operational data needed to operate the service. Blockchain-based platforms will therefore need to integrate with both the energy businesses’ legacy systems and to exchange data with third party participants. To enable that data to be shared optimally, it needs to be standardised so that it is compatible and can interoperate efficiently across the distributed blockchain platform. Some helpful progress in this area is being made: in the spring of 2016 the International Organisation for Standardisation (ISO) received official applications to establish a new field of technical activity on blockchain and other distributed ledger technologies. Although a useful step forward, it will take time to achieve truly international standards for blockchain.
A related concern is the current deficiency of acceptable governance models for blockchain-based technologies. Many prospective blockchain projects envision participation between various third parties within the energy supply market. Since control over the underlying blockchain ledger is (by definition) distributed, detailed participation agreements may be needed to govern access, set rules of conduct and to apportion accountability and liability. In the absence of a strong governance framework to define clearly the roles and responsibilities of the blockchain participants, blockchain platforms will continue to struggle to achieve widespread adoption, no matter how compelling the underlying business case.
While strong governance is crucial to ensuring the delivery of effective, predictable and sustainable blockchain services, different participants in a blockchain will have very different commercial drivers and expectations. Currently there is considerable debate in the blockchain community around what form governance over blockchain technologies should take. Getting it right will take time, effort and collaboration.
Regulatory uncertainty is also a major inhibitor to the adoption of blockchain. Regulators now recognise that innovation will play a vital part in shaping the future of the energy system and that advances in technology are already increasingly affecting how energy is produced, transported, managed and consumed. Importantly, they are beginning to appreciate that technological innovation alone is not the whole story — new business models and operating processes, empowered by innovations such as blockchain, can also drive greater market competition and realise benefits for energy consumers.
However, up to now authorities have shied away from engaging in discussions on how blockchain technologies might be regulated. Encouragingly, the regulators have started to show signs of wanting to engage more proactively to create the right regulatory environment to foster innovation. For example, in early December 2016 Ofgem announced its launch of Innovation Link, a service to help technology-led businesses looking to operate in the energy markets obtain rapid feedback on the regulatory framework and what it might mean for their ideas. The regulator is also considering introducing a regulatory “sandbox” (something already successfully used in other industries such as financial services) to enable new products and services, including blockchain-based projects, to be trialled in a controlled environment within the existing regulatory framework. Part of the aim of these regulatory initiatives is to facilitate competition through innovation, but they also enable the regulators to become more familiar with blockchain technologies and to start to consider how the regulatory landscape may be adapted in the future to support them.
Aside from regulatory concerns, other legal issues need to be worked through too. The legal enforceability of transactions effected via blockchain technologies is yet to be fully tested. The contract law regimes in some jurisdictions (including the UK) present potential issues, particularly for permission-less ledgers. For instance, some question whether there is sufficient certainty as to the parties’ identities and/or all the contractual terms between the participants in a blockchain to stand up to legal challenge.
A primary benefit of blockchain technologies is that they are capable of generating considerable efficiencies for cross-border transactions, as the nodes on a blockchain can be located on servers anywhere in the world. In view of this, another significant enforceability question remains unanswered: who should have jurisdiction to hear any disputes and in what forum?
How blockchains handle data also needs consideration from a legal perspective. Any type of data can be encoded into a block for entry onto a blockchain. Where this is personal data (such as energy consumers’ billing or meter details) it will be widely transferred to every other node in the network, some of which could be located across geographical boundaries. Careful consideration must therefore be given as to how personal data transfers across distributed blockchains can comply with international privacy law. For example, principle eight of the UK Data Protection Act 1998 restricts (and places certain protections on) transfers of UK residents’ personal data outside of the European Economic Area. While ensuring data compliance for blockchains is not impossible (and a number of blockchain innovators are developing proprietary applications aimed at achieving this) all issues must be considered from the outset as part of the design process to ensure the blockchain’s underlying coding and protocols are programmed appropriately.
As is often the case with potentially transformative technological innovations, blockchain platforms are being developed faster than the existing regulatory and legal frameworks can be adapted. Nonetheless, and despite other challenges, real world applications of blockchain technologies have already achieved some surprising traction within other industries such as financial services, where both disruptive start-ups and incumbent legacy firms are investing seriously, either in competition or collaboration, in ways to leverage the technology and realise some of the enormous potential benefits it offers.
Whether blockchain will gain similar maturity in the energy sector remains to be seen; proponents of the technology see no reason why it should not. Looking past the hype, however, it is clear that considerable work remains to be done, with significant further collaboration required between industry and regulators to deliver workable, secure and compliant blockchain solutions. In our view, therefore, it feels unlikely that 2017 will be the year for widespread blockchain adoption in the sector. Nonetheless, it would be a daring C-suite which decided to dismiss its potential and not keep a close eye on where this technology is heading.
Chris Bates and David Futter are partners at Ashurst in London.
This article was first published on Ashurst’s Insights Blog.