Road to Success

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.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.