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Mr. Dewey

Hospitality Law

Preparing for the Deployment of Blockchain in the Hospitality Industry

By Josias Dewey, Partner, Holland & Knight LLP

Co-authored by Joseph Guay, Partner, Holland & Knight LLP

Earlier this year, the travel company Webjet announced it was in the process of converting a blockchain pilot it had developed into a commercial grade application. The blockchain-based application will be able to provide accurate information about hotel inventory, on a real-time basis, for hotels around the world. Yet, this application of the technology may not have the biggest impact on the industry. Hailed as the best use case for blockchain by the Harvard Business Review, loyalty reward systems are the target of significant investment by blockchain companies looking to add functionality to a system of critical importance to the industry.

Overview of the Technology

Perhaps the least understood technology in recent years, blockchain, or as it is sometimes referred to, "distributed ledger technology" ("DLT"), is particularly difficult for many to conceptualize. Even the terms "blockchain" and "DLT" technically refer to slightly different concepts, where the term blockchain is a subset of DLT. More specifically, DLT is generally understood to describe a collection of techniques or methods that result in a distributed, peer-to-peer network of computers that, through the operation of a common software protocol, can achieve "consensus" on a single version of truth about some facts or "states," each of which is recorded on a ledger (think database or spreadsheet). That ledger, in turn, is identically replicated on each computer (or for some data, two or more computers to the exclusion of others) connected to a network. The result is a network of computers where each user can trust that the records on his or her copy of the ledger are identical to every other copy maintained by the network and that any change to one copy will be made to every other copy-or more simply, a golden source of truth.

The term "blockchain" refers to a system that implements the above characteristics, and in addition, processes groups of data entries or "transactions," known as "blocks," where each block includes a unique cryptographic marker of the prior block. This pattern of chaining blocks so that each block is inextricably linked to the prior block gives rise to the term "blockchain". For certain applications, most of the benefits achieved by blockchain can be realized from DLT without the need for this pattern of storing data in blocks. As we will see below, this is especially true for ledgers not designed to be accessible by the public, but rather are private or otherwise require permission in the form of credentials to gain access.

This nuance is one of several that can alter the characteristics of a form or type of DLT or blockchain. An entire book can be written about DLT and blockchain, which requires us to overlook many of these nuances, and instead, focus more on the capabilities of DLT and blockchain in the context of hospitality and less on how it achieves them. From this point on, we will use the terms blockchain and DLT interchangeably, and treat most technical matters as a "black box". Just as you don't need to understand TCP/IP protocol to understand the value of the internet, you don't need to know how blockchain protocols achieve "consensus" about their data to understand the value of DLT.

Application to Hospitality

There are several applications of DLT that offer potential benefits to the hospitality industry. Likely the use case receiving the most attention, transitioning existing centralized reservation systems to a DLT-based system offers several benefits. The most significant of which is the elimination of much of the expense of reconciling the amounts owed to each industry participant (e.g., travel agencies) who may be owed a fee for the generation of a booking. The variety of means through which bookings arise and the lack of transparency in many of those transactions has led to an expensive process to reconcile and distribute these payments. This use case highlights the power of combining automation and a trusted ledger that records all relevant data (and maintains its integrity).

Some have suggested the logical result of this application is to eliminate the need for travel agents and other booking services. This is yet to be seen and arguably this layer of the industry adds value beyond what DLT can accomplish, such as industry marketing and a more seamless price comparison interfaces (i.e., it's hard to imagine all hotels agreeing on a common price comparison utility for consumers). In any case, significant benefits for all parties in the value chain can be accomplished through quicker payments and reduced back office overhead without the need to disintermediate any existing industry participants.

Loyalty Rewards

Earlier in the year, the Harvard Business Review declared loyalty reward points as the greatest application of blockchain technology. Whether this is the case is subject to debate, but it is generally accepted that many loyalty reward systems could exist on blockchain within the next few years. Given the importance of cross-marketing efforts in the hospitality industry, such as between hotels and car rental companies, being able to automate the reconciliation of points programs redeemable among two or more companies would reduce the cost of administering these programs. In addition, blockchain can help address the challenge of accurately tracking customer data in order to identify business origination and just how much one company is contributing to the success of the overall marketing program. More reliable data in this regard would permit the more efficient use of a company's marketing budget by allowing it to deploy more resources to higher value programs.

Supply Chain and Provenance

Perhaps more than any other use case, the application of blockchain to supply chains, including provenance around the integrity of purchased goods, and related trade finance, has the potential to revolutionize global commerce. This has important implications for an industry that needs reliable supply chains to deliver constituent goods of a specific quality to have satisfied patrons. This prospect of increased efficiency and reduction in costs along the supply chain is also one of the most difficult to implement in the real world.

The sheer number of participants involved in the average global supply chain can include numerous parties, each of whom must be on-boarded to a common blockchain to maximize the value of the system. This includes government officials in several countries, such as customs and taxing authorities, shipping companies, freight and logistics providers, insurers, merchant lenders and many others. Reaching agreement on a common system among that broad and diverse a group will take several years.

During this period, hotel operators will need to consider their role and place in such a blockchain, and whether an industry-specific, or in some cases, a company-specific blockchain, is desirable. If industry specific, how will hospitality companies organize to develop such a platform? Are there other examples of industry cooperation from which valuable insight can be found? The notion of "blockchain consortiums" is an important one in other industries, such as finance, but the unique sharing capabilities coupled with an organization of competitors also gives rise to serious antitrust considerations. Industry players considering such an organization should be cognizant of antitrust issues, lest they want to attract scrutiny from the Justice Department.

Hospitality companies continually make investments in an effort to reduce procurement expenses. Avendra, born out of some of these industry efforts, operates as a central procurement company allowing the hotel and other industries to enjoy greater economies of scale; which, in turn, should lead to more favorable pricing and a consistent stream of quality products. Blockchain has the potential to increase those economies of scale, while reducing the agency costs associated with operating a centralized point of purchasing. Given the importance of procurement in the industry, companies will continue to explore ways to create more efficiencies in purchasing the goods and services needed to operate hotels, and blockchain technology will almost certainly play a significant part of those efforts.

Legal Considerations - Payments

We have not addressed the first implementation of blockchain, "Bitcoin," and its use (along with other digital currencies) as a means of payment. Ironically, the application that receives the most attention in the media, raises few legal issues in the context of merchants accepting virtual currencies in exchange for goods and services. There are practical considerations, however, that must be addressed, such as hedging against the volatility in the exchange rates between virtual and fiat currencies (e.g., the price of bitcoin can often fluctuate 30% or more in a matter of days) and security around maintaining control over bitcoin and other virtual currencies, which use a rather complex (but highly secure) public key encryption scheme to allocate the entitlement to spend any given unit of a virtual currency.

There exist several developer groups and Fintech companies that can assist merchants who want to accept bitcoin and other virtual currencies as payment. One important consideration for a merchant accepting bitcoin is the IRS's treatment of virtual currencies as property rather than currency. The effect of this is to subject any increase in the value of a virtual currency vis-a-vie the Dollar as taxable income upon the subsequent disposition of the virtual currency by the merchant. Thus, if a merchant holds the virtual currency for any appreciable period, it may need to account for any appreciation of value and pay tax on any gains, subject to offset for corresponding losses when the value of the virtual currency is declining.

Legal Considerations - Privacy

With the implementation of General Data Protection Regulation ("GDPR") in the EU coming in 2018, privacy rights are once again a hot topic. The GDPR is a regulation by which the European Parliament, the Council of the European Union and the European Commission intend to strengthen and unify data protection for all individuals within the European Union ("EU"). It also addresses the export of personal data outside the EU. The GDPR aims primarily to give control back to citizens and residents over their personal data and to simplify the regulatory environment for international business by unifying the regulation within the EU. This has led some to express concern with the ability of blockchains to remain compliant with certain aspects of privacy related legislation, such as the "right to be forgotten" under EU law. The notion of an immutable ledger from which data cannot be deleted is seemingly inconsistent with a person's right to have certain personal information scrubbed.

There are several important mitigating factors. First, while DLT is often described as being immutable or "append only," this is not always the case and those desiring to create a DLT protocol can remain compliant by (i) establishing rules that permit network participants to alter the ledger with respect to personal information covered by legislation, and (ii) perhaps more importantly, limit the data that is stored on the ledger to data not subject to these types of restrictions. Second, while Bitcoin and Ethereum are public ledgers, most enterprises will likely utilize, at least initially, private or permissioned ledgers that restrict access to the data to identified participants. Finally, protocols being developed for enterprise use, include the ability to control what data individual participants on the network can access. This sort of granular control will help rather than not deter industry efforts to comply with legislative frameworks, like GDPR.

Legal Considerations - Cross-Border and Compliance

The discussion of GDPR is just one example of the cross-border implication surrounding DLT. Issues involving or whose outcome is dependent on the location of a network are even more difficult to resolve than with traditional "cloud" technology. With DLT, the location of distributed nodes-potentially around the world-means there isn't even any location housing a server. The problem is particularly confounding with public blockchains that effectively exist everywhere, and yet nowhere. Yet, for multinationals, these types of issues have become a way of life, and DLT offers the prospect of reducing the burden of complying with disparate and scattered regulatory regimes. Another prominent feature of DLT is the ability to embed business and legal logic into the network, which can be geo-location specific. So, the network can determine where conduct is occurring and default to the application of the appropriate regulatory requirements in an automated fashion. Subject to maintaining this logic and updating for changes in law, these systems have the potential to automate many compliance processes currently being done through manual processes.

Legal Considerations - KYC/Anti-Money Laundering

In the context of loyalty points, it's important to note that the same FinCEN guidance that applies to prepaid cards and points systems is equally applicable to those products if implemented on blockchain. To the extent transferable, rights evidenced as a digital entitlement on a blockchain (often called a "token" or "tokenizing" an asset) raise concerns because of the increased liquidity that may exist on secondary markets. Often, these secondary markets create liquidity in digital assets traditionally considered illiquid by reducing the otherwise high transactional costs incurred to exchange points among users. This increased liquidity can cause the points to take on qualities generally associated with other substitutes for money-such as bitcoin.

The risks associated with this increased liquidity can be addressed, however, when designing the attributes of a proposed digital loyalty point, including appropriate restrictions on transferability. In addition, these rights within the hospitality industry are generally not transferable as the right to occupy a room is personal to the party booking it. If increasing the liquidity of loyalty points is determined to be strategically beneficial, in-house counsel must be cognizant of the increased risk that the points will be used to launder funds generated from illicit activities, and the implications of this under U.S. and other applicable anti-money laundering efforts.

Preparing for the Future

While widespread adoption of blockchain technology may be a few years away, the time to acquire the knowledge and assets needed to deploy the technology at an enterprise of any scale is likewise measured in years. In addition, the development of the technology is moving forward at a rapid pace, and only those involved have a seat at the table. It is important for companies to consider the benefits of being involved in the design and architecting of systems that will have a significant impact of their operations. If not already on the radar, now is the time to begin developing a strategy of how an enterprise will study, monitor and participate in the development of DLT. The need is particularly important for hotel operators, who should already be considering what, if any, changes should be incorporated in new operating agreements or renewals of existing ones.

With adoption of these systems a likely possibility within the next three to five years, many of the agreements entered today will still be operative when DLT systems go online. Consider whether existing concepts around reservation systems, co-marketing and branding arrangements, purchasing discounts and capital expenditure budgets, among others, will align with the operator's future strategy with respect to the adoption of DLT in the industry. While no one has a crystal ball, we can all benefit from continued education on the implications of DLT for the hotel industry.

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Joseph Guay co-authored this artcle. He is a partner in Holland & Knight's New York office and serves as the firm's Real Estate Section leader and co-chair of its Hospitality, Resort and Timeshare Group. His practice is focused in the areas of real estate, business and commercial lending with a strong emphasis in hotel and resort development and hospitality law, including hotel acquisitions and dispositions, development and finance, mixed-use development projects, hotel management agreements, branded residential projects, restaurant agreements and general hotel operation matters throughout the U.S., Latin America and the Caribbean. He represents national hotel company owners and operators, pension fund advisors and investment funds, and real estate development companies, institutional lenders and investment banks.

Josias N. Dewey is a partner with Holland & Knight LLP and the leader of the firm’s Miami Real Estate Practice Group. Mr. Dewey is a financial services and real estate attorney and is a thought leader on blockchain and distributed ledger technology. He is the co-author of “The Blockchain: A Guide for Legal and Business Professionals,” the first-ever book on blockchain technology and the law. Mr. Dewey regularly represents large international banks to local community banks, as well as insurance companies and investment funds. His finance practice encompasses a broad range of asset classes and transaction structures. Mr. Dewey can be contacted at 305-789-7746 or joe.dewey@hklaw.com Please visit http://www.hklaw.com for more information. Extended Bio...

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