Cryptocurrency and blockchain are terms that have repeatedly
found their way into legal headlines recently. But many
practitioners and judges aren’t yet familiar with what they are
or the legal implications they present. In this episode, Jody
Sanders and Todd Smith join Nelson Ebaugh, a litigator and appellate
attorney in Houston, to discuss this technology and the legal
issues it raises. Nelson has found himself on the forefront of
cryptocurrency litigation and provides a history and understanding
that’s accessible to laypeople. He also offers insights into
areas of the law that have started affecting cryptocurrency (like
securities, criminal law, and privacy), where legal issues will
continue to develop, and how attorneys can position themselves to
have an impact.
Our guest is Nelson
Ebaugh, who has his own firm in Houston.
Thanks so much for joining us.
My pleasure.
If you would maybe spend a few minutes and talk about
your background, your path to the law, and what you do
now.
I graduated from the University of Texas in 1991. I first worked
on Capitol Hill for the Republican Study Committee. It was a
fascinating experience. That is when I decided I wanted to look
into law school. I enrolled in the University of Tulsa Law School
in 1995. I’m one of the few people that went to law school that
enjoyed the experience.
Afterward, I worked as an Assistant District Attorney in Colin
County. I enjoyed that, but I also wanted to get involved with
business litigation. I worked for a couple of years with a business
litigation firm in Addison near Dallas. I earned my Master of Law
in Securities and Financial Regulation in Washington, DC. I enjoyed
that too. The best part about it is that it is where I met my
wonderful wife. She is also a lawyer. She was earning her
master’s in Securities and Financial Regulation at the same
time.
By coincidence, we both happened to be from Houston. After we
finished the program, we moved back to Houston. I worked for a firm
in Houston for several years doing business litigation. I decided
to hang my own shingle. I have been doing that for several years. I
do a mix of both business litigation and criminal appeals. Amongst
the business litigation cases that I handle, I do a lot of
securities litigation and securities arbitration. Through that
work, I became interested in how cryptocurrencies and the law work
together. That is what brings me here.
We were glad you reached out to talk about
cryptocurrency because Todd and I, before we started the interview,
had both admitted we were novices in that area. Everything that we
know we learned from our friends Karen Delaney and Jennifer
Judges’ podcast Lawyers Behaving
Badly. They did a deep dive on crypto and FTX
for the first couple of episodes. If you wouldn’t mind spending
a few minutes breaking down crypto and blockchain and simplifying
it for guys like Todd and me who don’t understand what it
is.
I had a steep learning curve when I was first presented with a
cryptocurrency fact pattern, but the more I learned about it, the
more I found out that the concepts are easy for a lawyer to get
their arms around. You keep on hearing about blockchain, and at
first blockchain sounds mysterious, but it is a simple concept. It
is a method of record keeping. A good analogy is that the real
estate records are all recorded here in Harris County for Houston.
That is a detailed record of all the real estate transactions in
the county, but it is centralized. In other words, it is all in one
place.
The way blockchain is different is imagine if you have over
10,000 copies of the Harris County deed records spread out across
the world. That is what the blockchain is like. In other words,
instead of having all the records in one spot, you have them spread
out throughout the whole world. All the 10,000 people that have
that record have to agree that they all have an exact copy of the
other 9,999 copies that are out there. That is one way to describe
a blockchain.
Another way to describe it is like an Excel spreadsheet that
over 10,000 people have the same copy of. They all agree that there
are over 10,000 copies that are the same. The reason that the
system was developed was to get away from the centralized
record-keeping system that you have with deed records or, more
specifically, banks. We are all familiar with how our banks keep
track of all of our assets and liabilities. I hope that gives you a
general idea about what a blockchain is.
In cryptocurrency, each cryptocurrency transaction is recorded
on this blockchain. In other words, it’s these over 10,000
different ledgers. As long as everybody agrees on the accuracy of
all of them, theoretically, you have a system where you can
exchange cryptocurrencies here and there. I can elaborate a little
bit more about why this system came into existence. That will help
put it in perspective. Would you like me to do so?
Yes, that is great.
The whole thing makes me think about it as a common
server, as it were. People have access to the same bits of
information and can make changes within that
environment.
Yes, with one caveat. One of the big buzzwords in blockchain and
cryptocurrency is that the blockchain is immutable. In other words,
it can’t be changed unless everybody agrees it is changed.
Blockchain And Cryptocurrency: One of the big buzzwords in
blockchain and cryptocurrency is that the blockchain is immutable.
In other words, it can’t be changed unless everybody agrees it
is changed.
I was going to ask about that. How changes are made if
you have 10,000 copies of it, and everyone has to
agree?
Let me back up a step, and I will talk about how cryptocurrency
came into existence in the first place because it is a fascinating
story. In 2008, we remember the financial crisis. When that
occurred, there were a lot of bank bailouts. Quite a few people
were upset about all these banks being bailed out. They were
frustrated in trying to think of alternatives.
The people that came up with the idea of cryptocurrency are
libertarians. They don’t like centralized institutions like big
banks and government. They wanted to come up with a system that got
rid of the middleman like big banks. That is the whole thrust of
cryptocurrency. What is interesting about it is that cryptocurrency
is almost like a religion. It is fascinating to see these
cryptocurrency proponents talk about the system and what it is
about. This whole idea of cryptocurrency is like a religion or a
political movement. They cannot stand big government or big banks.
Having this distributed ledger system is appealing to them because
they don’t have to rely on a fiduciary like a bank to have
transactions conducted.
Back up to 2008, this is where the story gets interesting. The
person or people that invented cryptocurrency-we don’t know who
they are. It is an anonymous group that goes under the pseudonym
Satoshi Nakamoto. He is probably not a real person. They have tried
to identify who Satoshi Nakamoto is without any success.
This person named Satoshi Nakamoto came up with this new
alternative financial system. He did so by publishing a white paper
that he spread amongst people on the internet. People on the
internet that liked it decided they would help Satoshi Nakamoto
create this cryptocurrency system and blockchain by using the
cryptocurrency called Bitcoin. Bitcoin is the first cryptocurrency
in existence.
I love this explanation of what cryptocurrency was all about in
2008. They have described it as, at first, an anarchist project,
like what I have been talking to you about it. It morphed into a
get-rich scheme. Now it has morphed into a solution and search for
a problem to solve. That is a brief quick history of cryptocurrency
since 2008.
How does it work technologically or practically that if
someone wants to make a new transaction on the ledger, you need to
get all the people to agree to that? How does that
work?
My thinking is, what is the dispute resolution
system?
I have a bachelor’s degree in Economics. I feel like I can
approach that part of it, but I do not have any education in
Computer Science. I can’t tell you exactly how technically it
works, but I can explain the general concept.
That is what we want. If you went to Computer Science,
it would probably go over our heads too. That is completely
fine.
There is a verification process. Have you ever heard of these
miners with cryptocurrency? What have you heard about the
miners?
That is a thing that they do. I know Texas has had a
bunch of people come in and set up Bitcoin mining operations to
uncover the new Bitcoins and set up all the computers. Everything
runs through the process of finding new Bitcoins.
The miners are essential in the verification process for
transactions. Let’s say that Nelson is sending one Bitcoin to
Jody. I would make that arrangement on my laptop. These miners
would verify that transaction. That verification process involves
solving complex math problems. I hit the limit on how that portion
of it works. They compete against each other. Whoever can verify
the transactions first and solve these problems that are part of
the system earns a reward of Bitcoin. There is an incentive
there.
Let’s contrast it with your normal bank account. I have a
bank account at Chase. Chase is a fiduciary that watches over my
money and makes sure the transactions I engage in are accurate.
Let’s switch back to the blockchain and cryptocurrency system.
In the blockchain and cryptocurrency system, you don’t have a
centralized record-keeping group or entity.
Instead, it is all these thousands of miners that maintain the
blockchain. They verify these transactions. If they are the first
to do so, they get a reward and get paid a certain amount of
Bitcoin. There are a lot of miners who have migrated to Texas over
the past few years. The reason for that is that energy is cheap
here. You have probably heard in the news about how mining is
energy-intensive. That is why they are here in Texas because it is
cheap energy for them to verify all these transactions.
How are the miners set up? Are these guys in the
basement like the usual hacker types? Are these legit companies
coming in, setting themselves up, and taking advantage of our
general business-friendly climate, aside from low energy
cost?
They are legitimate companies. In order to be a successful
miner, you’ve got to have an enormous operation going on. For
instance, there is a little town only about an hour’s drive
from Austin called Rockdale. There used to be an Alcoa aluminum
plant there. They went out of the aluminum business and converted
it into an enormous mining facility.
The reason they chose that location is that when it was owned by
Alcoa, they had already hooked it up with a lot of electricity from
power lines. It provided a good infrastructure for this miner to
operate under. These mining shops can be enormous and require a
large investment to get going. I have heard about some of these
small-time miners that maybe have a laptop running in their
basement, as you referred to, but I don’t think they are what
is keeping this whole system together for the most part.
It seems like there has to be a large scale of operation
to make it work efficiently and to have any prospect of earning the
reward.
The city of Fort Worth got into the Bitcoin mining
business on a small scale. I don’t know if they were gifted or
they bought some mining machines, but they set them up. My city is
in the Bitcoin mining business to a small extent.
I’m going to ask another question. We are hearing a
lot, aside from Bitcoin and blockchain, in the news about
artificial intelligence. I wonder how the emergence of AI as a
player in the legal industry impacts the Bitcoin mining
business.
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