Probabilistic Settlement Finality in Proof-of-Work Blockchains: Legal Considerations
40 Pages Posted: 3 Feb 2022
Date Written: January 31, 2022
The concept of settlement finality sits at the heart of any type of commercial transaction; whether the transaction is in physical or electronic form or is mediated by fiat currencies or cryptocurrencies. Transaction finality refers to the exact moment in time when proprietary interests in the object or medium of transaction pass from one party to his counterparty and the obligations of the parties to a transaction are discharged in an unconditional and irrevocable manner, i.e., in a way that cannot be reversed even by the subsequent legal defenses or actions against the counterparty. Given the benefits of finality in terms of legal certainty and its potential systemic implications, legal systems throughout the globe have devised mechanisms to determine the exact moment of the finality of a transaction and settlement of obligations conducted using fiat currencies as a medium of exchange. However, as the transactions involving cryptocurrencies fall beyond the scope of such rules, they introduce new challenges to determining the exact moment of finality in on-chain cryptocurrency transactions. This complexity arises because the finality of the transactions in the cryptocurrencies that rely on proof-of- work (PoW) consensus algorithms is probabilistic. The probabilistic finality makes the determination of the exact moment of operational finality nearly impossible.
After discussing the mechanisms of settlement of contractual obligations in the traditional sale of goods as well as payment and settlement systems - which rather than relying on the concept of operational finality, rely upon the concept of legal finality - the paper argues that even in the traditional payment and settlement systems the determination of operational settlement finality is nearly impossible. This is because no transaction, even a transaction involving a cash payment, cannot be operationally deemed irrevocable as it remains prone to hacks or unwinding by electronic means or mere brute force. The paper suggests that the concept of finality is inherently a legal concept and, as is the case in the conventional finance, the moment of finality in PoW blockchains should also rely on the conceptual separation of operational finality from legal finality. However, given the decentralized nature of cryptocurrencies, defining the moment of finality in PoW blockchains, which may require a minimum level of institutional infrastructures and centralization to support the credibility of the finality, may face insurmountable challenges.
Keywords: Cryptocurrency, Bitcoin, Blockchain, Finality, Payment, Settlement
JEL Classification: E42, E51, E58, G01, G23, G28, K22, K23, K24
Suggested Citation: Suggested Citation