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.
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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