Smart contracts – how important are they to the future of legal practice? Part 2

The challenges of putting smart contracts into practice

Clients are not going to want to enter into smart contracts unless they are legally binding because even if they are self-enforcing things can still go wrong.

The code could not work the way the parties or the author intended[1] or the author could have “fat fingers” and make a mistake without realising[2].“Moreover, given the capacity for computer programs (and their coding) to spontaneously corrupt, in which case neither party is necessarily ‘responsible’, there is potential for disputes as to liability to arise if the risk of technical error eventuates.”[3]

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Globally countries have not legislated for smart contracts specifically[4] and it is expected that smart contracts will be adapted into traditional contract law[5] and laws related to electronic transactions that have been introduced in many jurisdictions.[6] Smart contracts will not necessarily fit neatly within regular contract law.[7] Potential incompatibility could undermine the prevalence of smart contracts.

Living in Australia where a former Justice of the High Court has said, “I am incapable of sending or receiving emails…The consequence is that I read emails only after they have been printed out for me…”[8] there are likely going to be serious issues for judges and legal teams to be able to actually interpret code or the implications of code to be able to formulate judgements and legal strategies respectively.[9] They will inevitably need experts to assist them, creating additional costs and time spent on matters.

 

Additionally any attempt to reference materials that the code was based on could be hampered at least in Anglo-American Common Law jurisdictions by the “parole evidence rule which prohibits reference to such materials where the express terms have been reduced to a final written agreement.”[10]

It is important to note the exact opposite argument has also been put forward with some arguing “Courts are going to be more likely to enforce smart contract terms because the courts will have more certainty as to party intent because the parties explicitly laid out their terms.”[11] The validity of this argument will likely depend on the complexity of the terms.

 Finding a solution

 It has been proposed that those writing smart contracts will be incentivised to write them in line with legal expectations.[12] This does appear to be the case with some smart contract developers seeking legal consultation to ensure compliance.[13] For example, following English Common Law and ensuring that both parties to the contract are named.[14] There is also the possibility of dispute resolution existing within its own dispute mechanism rather then being spread across jurisdictions, an analogy being drawn with maritime disputes that are tried in their own courts in London[15] or sporting disputes decided by Court of Arbitration for Sport in Lausanne. Given how well blockchain facilitates the creation of contracts across the world this could be the key development that will allow the growth of smart contracts and ensure its viability as a platform. Thus making it very important to the legal profession in the future.

  

[1] Mark Giancaspro ‘Is a ‘Smart Contract’ Really a Smart Idea? Insights from a Legal Perspective’ (2017) 33 Computer Law & Security Review 825.

[2] Jenny Cieplak and Simon Leefatt, ‘Smart Contracts: A Smart Way to Automate Performance’ (2017) 1(2) The Georgetown Law Technology Review 417.

[3] Giancaspro, above n 1, 829.

[4] Norton Rose Fulbright, ‘Can Smart Contracts be Legally Binding?’ (Working Paper, November 21 2016) <http://www.nortonrosefulbright.com/files/r3-and-norton-rose-fulbright-white-paper-full-report-144581.pdf>.

[5] Ibid.

[6] Ibid.

[7] Ibid.

[8] See https://www.theguardian.com/australia-news/2015/aug/31/dyson-heydon-i-read-emails-only-after-they-have-been-printed-out-for-me

[9] Giancaspro, above n 1.

[10] Ibid 832.

[11] Max Raskin, ‘The Law and Legality of Smart Contracts’ (2017) 1(2) The Georgetown Law Technology Review 305, 328.

[12] Ibid.

[13]Mattereum, ‘How to Make Smart Contracts Legally Binding?’ (13 December 2017) YouTube <https://www.youtube.com/watch?v=z5dX-8jdTKM&gt;.

 

[14] Ibid.

[15] Ibid.

 

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Smart contracts – how important are they to the future of legal practice? Part 1

What is a smart Contract? What makes a smart contract different from any other electronic contract?

In 1996 Nick Szabo defined smart contacts as “a set of promises, specified in digital form, including protocols within which the parties perform on these promises”.[1] This definition came about long before blockchain technology, which originated with a white paper created by an individual or collective under the pseudonym of Satoshi Nakamoto in 2008.[2] Hence, Szabo’s definition is not specifically a definition of a smart contract operating on the blockchain.[3]

Szabo used vending machines as an example of a “primitive ancestor of smart contracts”.[4] Using a vending machine depends on a human party actually tossing some coins in and making a selection.[5] In a smart contract however, the performance of the contract on both sides of the transaction is totally automated without any human intervention (apart from initially writing the code that is).[6] Perhaps a preferable definition is that “smart contracts are self-executing electronic instructions drafted in computer code”.[7]

These contracts being written in code and designed to execute automatically have a variety of characteristics that are a different to traditional contracts.

  • Completely electronic.[8] Smart contracts must be completely electronic to be self-enforcing otherwise they would depend on someone clicking a button or delivering some tangible property, undermining the entire point of the technology. This means that smart contracts are limited to contracts that “relate to digital assets (such as cryptocurrency), or to digital manifestations of offline assets, title to which is registered in Blockchain.”[9]
  • Conditional.[10] Although every contract stipulates conditions to be fulfilled in one way or another, because smart contracts are written in code there is no room for ambiguity or subjectivity. All aspects of the contract are written as conditional statements, essentially, if this then that.[11]
  • Predicted outcomes.[12] The combination of self-enforcing contracts and the conditional nature of the contracts mean that outcomes are guaranteed and can be predicted upon the occurrence of certain events.
  • Irrevocability.[13] Once the contract is on the blockchain it cannot be altered or stopped.[14]

How it actually works

A contract written in code and uploaded on the blockchain,[15] when the conditions of the contract are met, then the program automatically triggers the actions stipulated in the code. The contract itself is comprised of “the program code, a storage file and an account balance”.[16] The account balance can send and receive money in the form of cryptocurrency that exists on the blockchain, [17] such Ether on the Ethereum blockchain platform. Funds are distributed in accordance with the contract.

An example of a contract is one that is programmed to purchase stock of a company if that company reports a certain level of financial performance, say profits in excess of 200 million, if this occurs, the contract will be executed to buy the stock automatically with money being transferred to purchase a stock. The information regarding company performance should come from a reliable agreed upon third-party source that is coded into the contract. “Third-party information services provider[s]”[18] are known as “oracles” and provide a digital signature that is kept on the ledger.[19]

1*LiTJq8p1gTlvbzzbNj2MIg.pngA detailed diagram from Blockgeeks

Want to know more about smart contracts generally? Have a listen to The Ledger podcast on smart contracts. 

Taking people out of contracts

In a smart contract on a blockchain, at least theoretically, performance is guaranteed. Therefore lawyers will have less of a role in creating of contracts, as there will be less of an incentive to have a traditional contract that is enforceable in a court of law. This sentiment has been echoed by some in the industry who see smart contracts as a potential disruption to the workforce.[20]

This raises questions as to what role lawyers will play and to what extent smart contracts are pushing up against the traditional role of global legal practices in handling commercial transactions. It is these questions that I will address in this and my next post.

Firms working on mergers and acquisitions are likely to face pressures from this technology.[21] Allen’s has stated that their business model is being threatened because it relies upon exploiting a lack of trust[22] and that the work they do, “we design governance structures, we draft and negotiate contracts, and … we litigate”[23] only exists to provide security to contracting parties.[24]

Exploring opportunities of smart contracts

One possibility for law firms is to integrate smart contracts into their existing practice and offer it as a solution to clients. Lawyers could potentially engage in a consultancy role, brainstorming with clients to create smart contract solutions for their organisations.

The diagram below by the Actus Team poses questions that can help businesses when making a decision to use smart contracts. These questions could be used a starting point for conversation between firms and clients.

 

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Source: https://blog.auctus.org/smart-contracts-ideal-uses-cases-930a9ca6a02f

It has also been argued, “Lawyers are still useful, if not required (particularly in the case of complex transactions), to draft the content which is ultimately translated into computer code.”[25]

Lawyers and law firms could serve as facilitators and interpreters of smart contracts, helping organisations to navigate this technology. There is evidence that this is already occurring specifically in the financial services area where smart contracts are being enthusiastically adopted.[26] However, it should be acknowledged that law firms have to compete with global consultancy firms and large accounting firms that want to provide similar services.[27] In my opinion it would be advantageous for lawyers to become more familiar with the technical side of smart contracts and it has been suggested that lawyers “may need to gain a basic proficiency in coding”.[28] The prospect of which was balked at by most of my fellow students in The Global Lawyer, many of whom had not heard of blockchain or smart contracts. This response indicates the need for a culture shift within the legal sector, emphasising a broader and multidisciplinary view of the profession as opposed to simply being an expert in ‘the law’. If the tasks that were previously profitable become obsolete, it will be up to lawyers and law firms to monetise this new technology before they themselves become an anachronism.

This blog post so far has provided an optimistic outlook on the adoption and relevancy of smart contracts. There are in fact many limitations hampering the success of the technology.

 Will smart contracts become the norm?

 Yes and no. It is unlikely that smart contracts will wholesale replace traditional contracts because in a lot of ways they offer something very specific that is not compatible with all the different ways that contracts are used by legal practices.

As discussed above smart contracts are considered to be self-enforcing but most transactions cannot occur solely within the blockchain. As soon as a transaction exits the realm of the blockchain, for example contracts for goods and services, there has to be additional layers of technology and processes to make sure these things actually happen in the ‘real world’.[29] The question for lawyers is then, is it actually helpful or feasible for this contract to be part of a chain of transactions within a blockchain?

The answer really depends on what the aims of the contract are. Smart contracts have potential to bring supply chain transparency; for example, in the diamond industry where smart contracts could allow companies to track a diamond’s chain of ownership from its initial discovery.[30] However, where the contracts specify outcomes that require subjective human judgement to determine whether they have been fulfilled, then the blockchain may not be an appropriate solution. This could be a judgement of quality or effort that cannot easily be determined by an “oracle”, [31] such as a best efforts clause in distributorship agreement. It is the “rigid, inflexible and absolute”[32] language of smart contracts that is a key critique of blockchain as a panacea for all business and regulatory issues.

The technology and financial services sectors will likely see widespread adoption of smart contracts as the objects of the contract exist in digital form and the contracts can be executed solely on the blockchain.[33]

Security Concerns

 Security concerns have often been raised as another disadvantage of the system. This is particularly an issue in public blockchains with headlines often discussing thefts of Ether or Bitcoin[34] as there is a possibility of ‘51% attacks’ where a majority of miners can exploit the consensus process to validate transactions that should not be going through.[35] This will be less of an issue for global legal practices, as business will likely look to adopt permissioned ledgers as opposed to public ledges.[36] Permissioned ledgers being ledgers “where its participants are preselected or subject to gated entry on satisfaction of certain requirements”[37] making those kinds of attacks less likely.[38] Permissioned ledgers do not usually use miners to validate transactions[39] and any thefts will be traceable. They also go against the decentralised nature of blockchain but that’s a whole other blog post, one that I am not quite ready to write![40] However, permissioned ledgers by no means guarantee security and like any technology that purports to offer security to information or assets, it is subject to attack.[41]

Legal practices may need to evaluate potential security risks and partner with technology firms in order to ensure that information and currency is as secure as possible.

I hope this post has given you an introduction to the value and problems of blockchain adoption in legal practices. As well as a sense of how they are relevant to future legal practices. My last post will raise issues around the legality of smart contracts, a topic that lawyers will no doubt be advising clients on more in the near future.

 

This post was amended on 25 January 2017.

[1] Nick Szabo, Smart Contracts: Building Blocks for Digital Markets (1996), [5] <http://www.fon.hum.uva.nl/rob/Courses/InformationInSpeech/CDROM/Literature/LOTwinterschool2006/szabo.best.vwh.net/smart_contracts_2.html>.

[2] Satoshi Nakamoto, Bitcoin: A Peer-to-Peer Electronic Cash System (October 2008), <https://bitcoin.org/bitcoin.pdf&gt;.

[3] Alexander Savelyev (2017) ‘Contract Law 2.0: ‘Smart’ Contracts as the Beginning of the End of Classic Contract Law’ 26(2) Information & Communications Technology Law 116.

[4] Szabo, above n 1, [6].

[5] Savelyev, above n 3.

[6] Ibid.

[7] Reggie O’Shields, ‘Smart Contracts: Legal Agreements for the Blockchain’ (2017) 21 North Carolina Banking Institute Journal 177, 179.

[8] Savelyev, above n 3.

[9] Ibid 124.

[10] Ibid.

[11] Ibid.

[12] Ibid.

[13] Norton Rose Fulbright, ‘Can Smart Contracts be Legally Binding?’ (Working Paper, November 21 2016) <http://www.nortonrosefulbright.com/files/r3-and-norton-rose-fulbright-white-paper-full-report-144581.pdf>.

[14] Norton Rose Fulbright, Unlocking the Blockchain: A Global Legal and Regulatory Guide (July 2016) <http://www.nortonrosefulbright.com/files/unlocking-the-blockchain-chapter-1-141574.pdf>.

[15] Jenny Cieplak and Simon Leefatt, ‘Smart Contracts: A Smart Way to Automate Performance’ (2017) 1(2) The Georgetown Law Technology Review 417.

[16] Ibid 424.

[17] Ibid.

[18] Ibid 423.

[19] Ibid.

[20] James Eyers, ‘Blockchain “Smart Contracts” To Disrupt Lawyers’ (Financial Review, 30 May 2016) <http://www.afr.com/technology/blockchain-smart-contracts-to-disrupt-lawyers-20160529-gp6f5e>.

[21] James Eyers and Misa Han, ‘Lawyers Prepare for “Driverless M&A” as Smart Contract Era Dawns’ (Financial Review, 19 June 2016) <http://www.afr.com/technology/lawyers-prepare-for-driverless-ma-as-ssmart-contract-era-dawns-20160616-gpknyz&gt;.

[22] Ibid.

[23] Ibid [6].

[24] Ibid.

[25] Mark Giancaspro ‘Is a ‘Smart Contract’ Really a Smart Idea? Insights from a Legal Perspective’ (2017) 33 Computer Law & Security Review 825.

[26] Eyers and Han, above n 21.

[27] See for example, https://www2.deloitte.com/au/en/pages/financial-services/solutions/blockchain.html and https://www.mckinsey.com/industries/high-tech/our-insights/getting-serious-about-blockchain

[28] Brydon Wang, ‘Blockchain and the Law’ (2016) 19(1) Internet Law Bulletin 246, 250.

[29] Norton Rose Fulbright, Smart Contracts: Coding the Fine Print (March, 2016) < http://www.nortonrosefulbright.com/files/smart-contracts-coding-the-fine-print-excerpt-137900.pdf>; Peter Brogden, ‘Smart Contracts and Web 3.0: The Evolution of Law?’ (2017) 31(June/July) Computers and Law 15. Available for viewing at https://www.linkedin.com/pulse/smart-contracts-web-30-evolution-law-peter-brogden

[30] Barbara Lewis, De Beers Turns to Blockchain to Guarantee Diamond Purity (Jan 16 2018) Reuters <https://www.reuters.com/article/us-anglo-debeers-blockchain/de-beers-turns-to-blockchain-to-guarantee-diamond-purity-idUSKBN1F51HV>.

[31] Norton Rose Fulbright, Smart Contracts: Coding the Fine Print, above n 29, 12.

[32] Brogden, above n 29, 18.

[33] See for example, https://www.finextra.com/blogposting/13656/blockchain-and-derivatives-reimagining-the-industry

[34] See https://www.gizmodo.com.au/2017/07/37-million-in-ether-stolen-as-people-refuse-to-learn-their-lesson-about-cryptocurrencies/.

[35] Norton Rose Fulbright, Unlocking the Blockchain: A Global Legal and Regulatory Guide, above n 14.

[36] Ibid.

[37] Ibid 20.

[38] Ibid.

[39] Deva Annamalai, Blockchain – What is Permissioned vs Permissionless? (10 January 2017) Core Dump <https://bornonjuly4.me/2017/01/10/blockchain-what-is-permissioned-vs-permissionless/>.

[40] See https://www.reddit.com/r/Bitcoin/comments/3ew27l/permissioned_ledgers_and_closed_centralized/

[41] Norton Rose Fulbright, Unlocking the Blockchain: A Global Legal and Regulatory Guide, above n 14.

 

Blockchain and what it means for lawyers

Beverage maker Long Island Iced Tea Corp’s <LTEA.O> shares jumped 300 percent after the company said it would rebrand itself Long Blockchain Corp, the latest obscure U.S. firm to tap into the frenzy surrounding crypto currencies.

Long Island Ice Tea said it was shifting its primary business strategy to blockchain technology and was in the preliminary stages of evaluating specific opportunities to grow that business.

The company said it would still continue to operate its beverage business, under which it sells Long Island iced tea and Long Island lemonade.

https://www.huffingtonpost.com/entry/long-island-iced-tea-corps-shares-skyrocket-after-renaming-itself-long-blockchain-corp_us_5a3be14fe4b0b0e5a7a07052

The rise of Blockchain and the skyrocketing price of Bitcoin seem to have captured the imagination of the world with everyone, including soft drink companies trying to profit off of the hype. As a law student studying what it means to be a global lawyer, I am interested in how this technology could shape the future of the legal industry.

What is blockchain?

“A blockchain is a digital, distributed transaction ledger, with identical copies maintained on multiple computer systems controlled by different entities.[1]

It is the technology that allows bitcoin and other cryptocurriencies to function.[2]

This video explains it a lot better then I can:

To summarise the key characteristics of blockhain are that the technology is:

  • Distributed. Everyone in the network has access to the ledger.
  • Resilient to manipulation.[3] Since there is no central administrator and information is spread across nodes manipulating transactions is made more difficult.

This is clearly quite a simplified description that I will expand on throughout the blog series but if you are interested in learning about blockchain more generally I recommend, Blockchain Basics: A Non-Technical introduction in 25 Steps by Daniel Drescher.

Applying this technology to the legal sector

 Untangling blockchain technology from bitcoin is a task that is currently being undertaken in order to adapt the technology to solve challenges in industry specific contexts.

Blockchain’s features are of interest because the nature of the ‘chain’ means that each record is verified by the last.[4] Information or records have to be true (in the sense they are consistent with past records) to be added to the record.[5] Essentially it is a very effective assurance system.[6] For example you would not be able to send someone 6 bitcoins when you only have three.

Also the digital and distributed nature means that records and information are public to all in the system and are not controlled by a single entity who acts as a gatekeeper or administrator.[7]

This blockchain has been described as allowing “simultaneous record-keeping and validation”[8] combining two tasks that often require both time and money.[9]

The openness of this system combined with the security provided by the technology is what makes it so enticing.

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The legal profession plays a significant role in facilitating transactions, often ones that deal with providing information, securing information and exchanging information and naturally blockchain creates possibilities that seem to have captured the imagination of the profession.

The most discussed application of blockchain right now is smart contracts. Over my next two blog posts I will attempt to explore and demystify the possibilities of the technology as well as the legality of contracts on the blockchain.

Amended on Jan 23 2018

[1] Norton Rose Fulbright, Unlocking the Blockchain: A Global Legal and Regulatory Guide (July 2016) <http://www.nortonrosefulbright.com/files/unlocking-the-blockchain-chapter-1-141574.pdf>

[2] Alexander Savelyev (2017) ”Contract Law 2.0: ‘Smart’ Contracts as the Beginning of the End of Classic Contract Law’” (2017) 26(2) Information & Communications Technology Law 116

[3] Ibid.

[4]Steve Mansfield-Devine, ‘Beyond Bitcoin: Using Blockchain Technology yo Provide Assurance in the Commercial World’ [2017] (5) Computer Fraud & Security 14 <https://doi.org/10.1016/S1361-3723(17)30042-8>

[5] Ibid.

[6] Ibid.

[7] Ibid.

[8] Norton Rose Fulbright, above n 1, 7.

[9] Ibid.