Blockchain in Action: Smart Contracts

2017-02-17T17:13:10+00:00October 7th, 2016|

In our first blog in this series on blockchain, we examined how the decentralised ledger system works. While the ins and outs are highly technical, the applicability of blockchain to modern business, particularly through ‘smart contracts’, is both exciting and, for some, alarming.

Blockchain has the potential to change the role of financial and legal institutions in commercial transactions. The advent of smart contracts, which are self-executing and widely considered tamper-proof, is causing many to question whether technology has the potential to automate professions which seemed, until recently, essential.

Smart contracts are chains of code stored and replicated on a blockchain that self-execute. Being on the blockchain system, smart contracts are run and verified by many computers with no single source of control. The simplest example is where one person purchases something from someone abroad. Currently, such a transaction would be overseen by a third parties like eBay and PayPal, which would ensure that the goods are delivered, money is paid and records are updated. Instead, a smart contract negates the need for these third parties. On the shipping of the good, the money would be automatically and irrevocably transferred to the vendor. All of this would be kept track of via the blockchain ledger system.

Of course it is easy to see how such a simple transaction can be automated. What is more difficult, and what banks, research institutions and law firms internationally are pouring money into researching, is whether and to what extent, complex, commercial contracts can be automated.

‘The DAO’, a Decentralised Autonomous Organisation, provides a compelling complex example of the application of smart contracts to business. The DAO is the most successful, crowd-funding venture in history, raising over US$150 million. The DAO itself was set up for investing in other business ventures.  Interestingly though, The DAO has no governing body – no board of directors, CEO or executives. Instead, investors receive tokens, which allocate voting power. The whole organisation is then run democratically, through a system of self-executing contracts, whereby votes determine which ventures are to be funded. One of the first proposals made to The DAO was by DAMN, a Decentralised Arbitration and Mediation Network.

These are examples of some of the more progressive and anti-establishment uses of blockchain and smart contracts. There are uses, however, both small and large, which can be harnessed by existing institutions. For example, businesses could automate the paying of dividends to shareholders or the payment of trust fund distributions.

Of course, for lawyers the automation of commercial transactions does have the potential to diminish their role in these transactions.  Traditionally, lawyers have been required as intermediaries, to negotiate contracts, oversee their implementation and enforce and litigate contracts if necessary – essentially ‘profiting from the absence of trust.’ [1] With the prospect of blockchain technology enforcing trust, many speculate on what role lawyers have to play in the future.

Much of this analysis is, however, taking place prematurely. While smart contracts are a hot topic, considerable research and development is needed before they can offer a viable and widespread alternative to traditional methods of contracting and transacting. Furthermore, the fact that mainstream financial and commercial institutions are so central to the development of this technology indicates that we are most likely facing a future where smart contract technology is integrated into existing contractual frameworks.

Barclays, in a recent research paper, delineates some processes as automatable and others as requiring intervention, maintaining that nuanced interpretation, flexibility and dynamism are not able to be coded.[2] A smart contract is usually only that part of an agreement that is able to be coded and suited to automated processing. A smart contract is not likely to replace the whole of a contractual agreement between parties. The essential requirements for the formation of a contract must still be in place, i.e. offer, acceptance, consideration and intention to contract. However, with development, it may be possible for a smart contract to be a fully formed contractual agreement.  Blockchain and smart contracts continue to be an evolving area of the law.

In our next and final blog in this series, we will look at the vulnerabilities and risks of blockchain.

Sainty Law can help you make decisions and advise you on how to get the most out of blockchain technology. Contact us to get advice from our experienced lawyers.

[1] James Eyers and Misa Han, ‘Lawyers prepare for ‘driverless M&A’ as smart contract era dawns’, Australian Financial Review, 20 June 2016.
[2] Christopher D. Clark, Vikram A. Bakshi and Lee Braine, ‘Smart Contract Templates: foundations, design landscape and research direction’, Barclays Bank PLC, 4 August 2016.