Governments as Entrepreneurs (Part 2)

Foreword

In this previous article, we discussed how governments can better provide services to foreign entrepreneurs – specifically by using technology to enhance and streamline residency and citizenship-by-investment programs.

In this second part, we continue the discussion of blockchain technology by looking at how governments can act more like entrepreneurs by using technology to augment and enhance their services. Specifically, I will show the advantages of a blockchain/remote system to improve common services to both domestic constituents and foreign investors/entrepreneurs.

Each headline on the left is a different service that governments provide and how they can be improved or disrupted.

What is a Legal Entity?

Every country has laws and regulations that govern legal entities, which are defined as associations, corporations, partnerships, proprietorships, trusts or individuals that have legal standing in the eyes of law. [footnote] http://www.businessdictionary.com/definition/legal-entity.html [/footnote] A legal entity has the legal capacity to enter into agreements or contracts, assume obligations, incur and pay debts, sue and be sued in its own right, and to be held responsible for its actions.

I suggest that we use distributed ledgers or private/public blockchains to create new efficiencies for businesses, as well as remote registered agents and arbitration to enforce laws.

Blockchain for Legal Entities

One of the most fantastic advances in technology in the last decade has been the blockchain – a special kind of database that, as a core value proposition, helps reach consensus on the existence of a certain object. For instance, the bitcoin network has a distributed infrastructure worth billions of dollars – the most powerful supercomputer in the world, in terms of raw hashing power – that is used to prove that a certain number of bitcoin exist at a specific address.

This blockchain proof of existence has been extended to prove someone’s KYC, and to prove the existence of other tokens that represent assets either “on-chain” or “off-chain”. Essentially, ledgers, blockchains, and technology in this category are very effective at proving ownership, as the database cannot be altered once written, and it is immutable. This means that it is very easy for regulators to track the ownership of specific assets, and audit the trail to determine where the assets had traveled.

Using a ledger with cryptographic certainty allows everyone to be certain of the existence of a specific item, and optionally, have these transactions be made private and anonymous, or public. In either instance, we can be certain about the state of a network, even when malicious actors try to obfuscate or defraud it.

How can blockchain technology be used in providing services for legal entities? Well, the ownership of such assets (the UBO) can be both private and certain. We can allow for a shareholder to own, manage and control a legal entity with complete privacy and control. His KYC information can be checked at the point of incorporation using a KYC-chain. Likewise, by using a shared ledger, regulators can easily check if a person has been barred from taking the position of director of a company due to fraud, bankruptcy or negligence committed in the past.

Finally, the most important aspect is that a shareholder can now have the certainty of the ownership of their shares in a company because they control a private key, known only to them. A director acting maliciously cannot sign away the shares of a person. Instead of owning a physical share certificate, you control the private keys to vote and exchange shares, as well as have all rights afforded to shareholders, such as to receive dividends, etc.

Instant Verification of a Legal Document

Blockchains and distributed ledgers have an important feature that makes them ideal for use in government services: they are “immutable,” which means that they cannot be altered or changed, and thus, they are an excellent method for achieving consensus or proving existence. In the picture below, you can see a visualization of a process to verify that a document (or a company) exists on a blockchain.

Blockchain technology from Incorporation to IPO

The blockchain system that we have designed includes the ability to easily incorporate a company, and handle the registration of corporate secretary, agent, shareholders and directors (or members and managers, in the case of LLCs) from the moment of incorporation all the way to IPO.

Begin by making a short, clear set of company laws for a new type of company. For this special purpose legal entity, do not place restrictions on the number of shareholders or members. Such restrictions hold little value or veracity in today’s modern society. Secondly, do not place restrictions on the types of investors or shareholders that can be solicited for investment.

Next, set up legislation that allows entire companies to be governed digitally. Rather than requesting for ink signatures and paper documents, a system that is far more secure should be implemented: cryptographic security managed by an online platform, which shareholders and directors can log in using their private keys and securely access their shares or directorship status.

The entity should be recorded on a public ledger, so that other companies in separate jurisdictions can easily check to validate the entity’s existence and whether it is in good standing. Doing so would serve to make in-person apostille services unnecessary, but the loss of apostille revenues can be made up for by charging for access to the public ledger (although I would argue that such access really should be made free). Just look at Hong Kong and Singapore, where one can purchase company information and get instant access to their databases.

The actions of a company’s directors should be recorded in a private ledger that is accessible only to the firm. These directors should be held accountable by the company’s shareholders, who can view updates to the firm via, for instance, email. However, these directors’ actions should be held private to the outside world.

A government that implements a distributed ledger for some or all of the purposes outlined here has a better economy of scale – it can provide corporate services at a lower cost, yet retain revenues. It means that more companies will be registered in the jurisdiction, which allows shareholders to be certain of their shares. It also allows for easier transfer of private and public financing, both by debt and equity.

Share Dematerialization

One of the most important aspects of a company IPO or the issuing of an initial public offering is the dematerialization of shares. During this process, a share custodian will take custody of all the stock in the company, as the paper share certificates are replaced by a number in a database. This allows for the stock to be more quickly and easily traded.

A distributed private ledger has shares dematerialized from a company’s inception, which means that the costs incurred in the dematerialization process can be eliminated. A stock exchange can easily be manifest upon a governance platform that tracks KYC and AML, and is electronically auditable at any time. There are also arguments for making this system easily interoperable and able to connect to other stock exchanges easily.

Automatic Adherence to Law

When we have a private ledger that maintains the integrity of data, we can begin to write rules (read software, if-then statements) on this ledger that can help regulate many things. One of these is routine governance, such as yearly meeting requirements, quorum rules, or more esoteric rights allotted by shareholder agreements, which companies can be free to write themselves. Smart contracts will have a dramatic impact on legal and corporate governance industries worldwide for a very simple reason: computers do not make mistakes. Only the programmers writing the code can make a mistake, but with the code being open source and fully auditable, we can achieve a very clear, accepted mandate for how certain actions are undertaken.

Electronic Registry

Many countries have an electronic database, but even still others (including some leading jurisdictions) maintain a paper-centric companies house. Currently, a companies house is a public, private or semi-private ledger with the names of registered entities, as well as, sometimes, their directors or shareholders.

I posit that an electronic registry on a blockchain can give rise to many different advantages and efficiencies. Since the main function of a government is to maintain an accurate list of the legal entities that are live and in good standing, delinquent in some manner or struck off, it makes sense to make this list publicly available. A “blockchain” or distributed ledger presents the proper amount of control of private keys, privacy, as well as transparency, in the event of an audit.

Another key benefit: no more apostilles or certificates of good standing. When a government has a companies house that is electronic, it is easy for banks or other interested parties to check on the current state of the company.

Privacy

Within a jurisdiction, a company will issue a certain amount of share capital to its owners or set this aside as registered capital. This is the most critical aspect of the private chain – who owns what and when – and whether KYC information been properly and privately stored on file with a registered agent. When the entire system is digital, do registered agents even need to exist at all? If we have a fully electronic system, then perhaps we can have a bonded system, where people put capital at risk in the event of fraud, default or some other adverse action.

Some jurisdictions keep their companies house registry private, but ultimately, this is not the way to give shareholders privacy, as many registered agents and corporate service providers can give companies nominee directors or shareholders so as to obfuscate their ownership.

The following data should be made public:

• Date of incorporation
• Registered address
• Name of the company
• Capitalization of the company

Companies House API

An application programming interface (API) that allows third-party services to read or write from the electronic database can help generate innovation and attract foreign entrepreneurs. However, it would be wise for each country to create an API that doesn’t disclose companies’ contact information – unless opted-in by a firm – as this would likely create unwanted spam for their owners.

In some jurisdictions, anyone can freely form a company. In others, only certain individuals or entities are permitted to do so. But once you have established an electronic companies house, you can create an API that allows third parties to form companies on behalf of their clients and offer business-to-business (B2B) services to build on top of the API.

Allow Registered Agents to Access the Companies House System

Why not allow registered agents and corporate service providers to access the API? Singapore does this with its corporate regulatory authority, ACRA, as does Estonia with its e-Residency platform. However, both of these services require the foreign entrepreneur to visit the country or a consulate abroad.

If your country can develop a fully remote system that makes it possible for global citizens to form new companies in your jurisdiction, regardless of how many consulates you maintain abroad, then you will find a new client pool and a new source of income. Many countries are already doing this, but few have an API or use blockchain technology with an immutable data source.

Obviously, you will need to identify the person forming the entity, as well as ensure that he is who he says he is. This can be done through a know-your-customer (KYC) check, a process that involves verifying a client’s citizenship, residency and means of acquiring funds for his business.

By allowing KYC to be performed remotely, it becomes possible for a person to identify himself remotely, and form a legal entity instantly.

Online Registered Offices

The other area that is particularly centralized and tied to a specific location is the registered office. Along with governments, registered agents are the main businesses that receive profits from the setting up and maintaining of legal entities.

Registered offices are required in every jurisdiction in the world (except Syria and New York state). They are essentially offices that are required by law to stay open during regular business hours to receive services of process against companies for which they act as the registered agent. Once a service is received, they typically contact the owner of the company by email. Companies, in turn, typically pay the registered agent a yearly fee, as well as a government fee.

In practice, it makes sense that a company maintains an office and has a physical, registered address to which registered mail can be sent. However, physical mail is slow, can be lost, and is not without failure. As it stands today, there is not a widely accepted manner to deliver a legal process through email or its electronic equivalent.

Why not disintermediate the registered agent and allow the owner to receive a virtual service of process directly? Why not have a virtual registered office? Why do we need physical mail in the 21st century? Using an email box to receive a service of process would allow for the same process, as well as save time and cost, which would be preferred by those running a distributed team.

Winding-Down Process

When a company is wound down, the cessation of business must be published in a local gazette. Why not run this gazette with a public API that allows creditors and debtors to see when a company is planning to cease operations?

We can refer to the same public ledger to see when a company will close down, saving creditors as well as the general public time and money, as they would no longer have to read a Gazette daily to check that the companies that they interact with are still in business.

What I suggest above is that governments take an existing source of revenue – fees collected for the formation and renewal of legal entities – and improve these services by making them more time- and cost-efficient through the use of an electronic registry. Currently, governments have a monopoly on forming a legal entity and maintaining the laws, courts, and means of arbitration for dispute resolution. But this may not always be so, as DAOs, or distributed autonomous organizations, gain traction.

DAO’s

Jack du Rose is the founder of Colony, a company that is creating a way for people to work on a distributed team and be compensated, where the work is accomplished without a top-down approach. This has been referred to as a distributed autonomous organization (DAO). His take is a community-driven platform for collaborating on work. Instead of shares, users gain “nectar,” and the idea is that even without a legal entity, work can be collaborated on and contributions can be awarded. Though still in its early days, the company nevertheless has some very interesting ideas on the future of work.

Clearly, the trend is for teams to become distributed. For instance, Automattic (the parent company of WordPress, on which 20 percent of websites on the Internet are built [footnote] https://www.quora.com/How-many-websites-are-built-on-Wordpress [/footnote]) is a completely distributed company. Other successful companies also follow this model. There is a noticeable trend of globalization and distribution of teams. As Taylor Pearson notes in his book, “The End of Jobs,” the nature of work is changing, and an important trend to recognize – one that governments can capitalize on – is that of decentralization and globalization.

Eventually, the goal of a DAO is for it to run with complete autonomy, perhaps driven by code or robots, with self-executing code. This is not the work of science fiction – it is coming soon.

Remote notarization

We won’t talk about remote notarization at length in this section, as much of the topic overlaps with the previously suggested improvements in the first part of this article series.

Having facilitated company setup and bank accounts for hundreds of entrepreneurs, I find that one of the most time-intensive aspects of the process is the gathering of documents, particularly because these documents need to be certified, notarized or apostilled. Banks request many different documents to establish the good standing of a legal entity, as well as the identity of all UBOs (ultimate beneficial owners).

When an entity is in the process of being set up remotely, these documents are oftentimes passed back and forth through non-secure channels, such as unencrypted email. If a government is unable to put its companies house into the digital world, it should at least offer online notarization services, much like the U.S. state of Virginia has. [footnote] Virginia’s Bills SB 827 and HB 2318, which came into effect in July 2012, allows notaries in Virginia to perform remote notarization. [/footnote]

Remote Dispute Resolution

Lawsuits are expensive, in terms of both time and cost. However, this new technology can not only allow for a court or arbitration ruling to be advanced on a quicker timeline, but also for judgments to be enforced with less cost and effort.

Up until this point, an aggrieved party involved in a lawsuit will typically retain a lawyer, which oftentimes will cost the party $10,000 or more. (There is also little transparency on the billing process or actual services of the lawyers.) The lawyer will then enter the case into a venue (usually a court, or arbitration center, which comes with its own fees), and the plaintiff will be notified via service of process. After preliminary hearings and postponements and discovery phase, the court will move to a jury trial or bench trial, and there will be a judgment. With this judgment, oftentimes the aggrieved party will need to enter it into another court (assuming this is done internationally) to try and recover some or all of the assets of the debtor. Different jurisdictions have different asset protection laws (some ignore all foreign judgments), and the results may vary widely.

There should be an easier, quicker, less expensive way for parties with no trust to quickly solve business disputes.

For instance, Bitnation, the blockchain-based Governance 2.0 initiative, has a project called Pangea that, at its core, aims to act as a dispute resolution platform (though this project is still very early in its development, and is very flakey about actually moving ahead). The details are a bit hazy, and there is no test net or production code, but the idea is quite sound.

Currently, there is no venue worldwide for remote arbitration. Judge.me was a company that did this, but it has closed down, and as of today, we have not found an appropriate arbitration center that functions on a remote basis. A critical issue to arbitration is: will foreign courts recognize the judgment in a case? However, with the advent of blockchain technology and private keys that control assets (both on-chain and off-chain), there is an opportunity to make arbitration binding, without complicity from foreign courts. In other words, the parties in the arbitration could put “keys” in escrow, and allow for the arbiter to have binding, final resolution.

If more government involvement is needed, why not have several states or countries band together to create a regional dispute resolution center? If the Companies Act and M&AA allow for this, then arbitration can take place online, remotely and it would be recognized by local courts.

Investors and directors place huge value on being able to settle disputes quickly and affordable. Having confidence in minority shareholder rights and the court enforcement of those rights will benefit both investors and entrepreneurs.

Automatic Updates and Electronic Communication

Say, for instance, a company wants to shut down. Typically, the firm is required by law to post a notice in a local gazette, go through an auditing process, and finally receive approval after a certain period of time to wind down the company.

Under the system I suggest, all of this could be automated. Instead of posting in a local newspaper (it is unlikely that creditors even read these), a notice can be sent automatically to anyone who has read-only permission to view these types of company events. It could become common practice when doing business with a new company to create read-only email alerts so as to receive email or other electronic notification when a certain event has taken place.

Conclusion

The paperwork for legal, financial and tax purposes that we must file as entrepreneurs is astounding.

The unfortunate fact is that taxes and compliance procedures are often the slow, incompetent, bureaucratic, wasteful, and unfree aspects of our governments. However, for many jurisdictions, it does not need to be this way. Take a look at Singapore, a country that has one of the lowest tax rates in the world, but yet also has a net positive GDP inflow/outflow.

Proportionate right to the people to set up a company easily, and you’ll be surprised at their genius ability to create value where previously there was none. That’s what entrepreneurs do, inherently. Or, they leverage arbitrage situations and move value from a place of lower value to one of greater value. If you are reading this as a small government, you need only look at Estonia for an example where digital residency (with no tax consequences at the individual level) can create value where previously there was none.

When governments act as entrepreneurs instead of lawyers, they may work towards less regulation and more economic freedom, instead of more bureaucracy, red tape, and crony capitalism or corruption. If a system is efficient, then there is less incentive for people to, say, bribe officials to help speed up processes. By making systems efficient, we can help to seriously remove an element of corruption. What an easy win for investing in your country’s infrastructure – faster service and less corruption.