Smart Contracts 101: Will It Replace Lawyers

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Smart Contracts 101: Will Smart Contracts Replace Lawyers

(By Charlotte Lian)

 

Introduction

Smart Contracts and distributed ledger technology (‘DLT’) are gaining increasing levels of attention from a variety of industries that perceive it to be an efficient way to simultaneously cut costs through automation while also increasing the security of industry practices. Deceptively named, a smart contract is – technically – neither particularly smart nor a fully enforceable contract. A smart contract is commonly defined as a digital agreement between two parties that is executed automatically through encoded software – an ‘automated blockchain transaction’. [1] An example is the French insurance company AXA is currently trialling a flight insurance product ‘Fizzy’ using smart contracts on the Ethereum blockchain. If the flight is over 2 hours late, then the policyholder will be paid. The smart contract is connected to a database with accurate flight times. This smart contract removes the need for the customer to file a claim, and wait for the claim to be processed, likewise AXA will no longer need to process these claims manually.[2]

Between the varying definitions, the key common elements of a smart contract include:

  1. A pre-written computer code;
  2. Multiple identical copies of the code stored on a blockchain; and
  3. Ability to update the ledger based on self-execution.[3]

To different extents, Smart Contracts are said to represent a core proponent of the ‘fourth industrial revolution’[4] and has been predicted to upturn traditional contracting in the legal industry. What exactly is a Smart Contract? And what benefits and challenges will it present?

What is blockchain and what are the benefits?
Smart Contracts are enabled by the developments in DLT, particularly blockchain technology. The recent spike in attention to Bitcoin has also brought accompanying attention to the underlying Blockchain technology, a form of DLT. Blockchain technology uses a permanent digital ledger that is operated across a decentralised[5] open network to allow for automated transactions of irreversible and immutable nature. Transactions can now skip the middle man and yet still be more secure, efficient, and reliable. Much like the advent of the internet, it is hailed to be one of the most disruptive technologies in the twenty-first century.

As the blockchain is founded on the basis of cryptographic and mathematical principles, the increased security is perceived to be an important advantage. There is an increasing sentiment that institutions can be fallible and implement coercive policies or techniques. The technology relies on a public consensus based ideology. No individual party can easily frustrate or subvert the intended outcome, by creating a new consensus, as the amount of resources expended to provide Proof of Work (PoW) or Proof of Stake (PoS) would not be worth it. Because of the unlikelihood of intervention, theoretically by definition, performance is ensured.[6]

 

Will it replace lawyers? And other challenges faced by smart contracts

Many people have proposed that if financial transactions no longer require banks as the middle man, then contracts should no longer require lawyers as the middle man. This leap of logic does not account for the numerous challenges that accompany the mass opportunities available.

There are two broad classes of challenges facing smart contracts:

Firstly, there are legal doctrinal issues surrounding contract law requirements of legality and conscionability during formation, performance and possibly remedial stages of a contract. While there is increasing regulatory framework, possible disputes have not been addressed yet – for example, would there be a tort for negligent coding? What if the contract is required to be modified yet faces immutable conditions?

Secondly, the practical challenges in encoding certain legal terms that require nuanced and contextual interpretation such as the commonly used ‘best efforts’, let alone ‘reasonably commercial efforts’.  Practical challenges also include software bugs and technical issues including the scalability of large permissionless blockchains currently. For example, as every node on the Bitcoin blockchain contains a copy and new blocks are created every 10 minutes, if Bitcoin’s network was to process Visa’s 2000 transactions per second, the size of the blockchain would grow 1GB per hour. [7]

Proposed solutions for current challenges

Oracles

An Oracle, simply speaking, is an offline verification agent. As Smart Contracts require conditions to be met before executing the exchange as codified in the contract, an Oracle act as a gatekeeper (frequently in the form of a datastream or database) to confirm the conditions set have been met. Oracles can take the form of software, hardware, inbound, outbound and even consensus based oracles[8].

Permissioned blockchains

In contrast to permissionless blockchains, a permissioned blockchain is a private network and often designed and built for specific transactional purposes in mind. Existing institutions may run permissioned blockchains to enact certain benefits of blockchain architecture such as immutability of past transactions, faster data processing, and other security capabilities. Further, a permissioned blockchain will only grant access to parties that are privy to view the transaction. A recent example is the Australian Stock Exchange’s (ASX) decision to utilise blockchain technology to clear the settlements on the exchange. The expected benefits include real-time settlement of transactions, reduction in administration and compliance costs, and prevention against system crashes.

 

Conclusion

As seen above, smart contracts do not necessarily need to represent the entire contract but can prove to have significant benefits in executing specific, parameter contained contract terms or systems. It is a far cry to state that lawyers will be replaced anytime soon, but rather, smart contracts and the underlying DLT can streamline and support legal contracts providing significant benefits to multiple industries and clients.

References

[1] For further reading:

Szabo, N. (1997). Formalizing and securing relationships on public networks. First Monday, 2(9)

[2] For further information: https://fizzy.axa; https://medium.com/@TheCoinEconomy/the-new-kid-on-the-block-chain-axa-launches-fizzy-an-ethereum-based-smart-insurance-protocol-efc3811471e8;

[3] Lewis, A. (2016) A gentle introduction to smart contracts <https://bitsonblocks.net/2016/02/01/a-gentle-introduction-to-smart-contracts/>

[4] As coined by Klaus Schwab, Founder of the World Economic Forum. Defining development features Cyber-physical technologies

[5] Defined as ‘conditions under which the actions of many agents cohere and are effective despite the fact that they do not rely on reducing the number of people whose will counts to direct effective action’. Benkler. Y. (2006). The Wealth of networks: How social production transforms markets and freedom. Yale University Press.

[6] Raskin, M. (2017) The Law and Legality of Smart Contracts. Georgetown Law Technology Review vol 1:2

[7] Buterik, V. (2014) Ethereum White Paper, 33

[8] For example, Oracalize utilising TLSNotary-based proofs and Town Crier utilising Software Guard Exntensions

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