September 19, 2018

Blockchain and Beyond: Smart Contracts

Tsui S. Ng

Imagine a future where contracts look like this:

./peer chaincode deploy -n ex01 -c '{"Function":"init", "Args": ["{\"version\":\"1.0\"}"]}'

The term “smart contracts” was originally coined by cryptographer Nick Szabo in the early 1990s. Szabo saw a contract as a set of promises agreed to by a meeting of the minds. He aptly noted that computers make it possible to run algorithms. First, the contract terms are translated into code—a series of if-then functions. Once a condition is met, the smart contract will take the next step necessary to execute the contract. Thus, the term “smart contracts” refers to computer transaction protocols that execute the terms of a contract automatically based on a set of conditions.

Although the concept of smart contracts has existed for a long time, a real-world application has only recently been made possible due to developments in blockchain technology. Blockchain is commonly defined as a decentralized digital ledger in which transactions are recorded chronologically and publicly. In its infancy stages, blockchain was the mechanism that tracked cryptocurrencies such as Bitcoin. However, as the technology evolved, variations such as private, permissioned, and consortium blockchains have emerged. Ultimately, blockchain technology can facilitate many types of business transactions.

Historically, we have relied on established institutions such as banks and government to authenticate transactions—to verify that the people with whom we are transacting are really who they claim to be. The institutions act as middlemen to build trust between two parties that are transacting with each other. However, these institutions are not incorruptible. At times, they have become victims of foul play by external or internal actors. In fact, it can be risky to consolidate trust into one institution because it creates a single point of failure.

In contrast to a centralized system where only certain people can view and modify transactions, blockchain was originally developed as a decentralized ledger open to the public. A key feature of blockchain is that multiple parties can verify transactions instantaneously. Once the transaction has been properly verified, it is added as a new block on the blockchain. Thus, blockchain is a string of transactions where a new block is permanently tied to a previous block and thus immutable. By distributing trust among multiple users, it is implied that a decentralized ledger will be more reliable in exposing any faults with transactions.

Smart contracting is a disruptive advancement that will have far-reaching impact for many industries, including financial services, government, real estate, manufacturing, and healthcare. For example, in securities trading, it currently takes several days to transfer assets, thereby increasing counterparty risk. Smart contracts that use blockchain technology could shorten settlement times and mitigate such risk. In the insurance industry, certain policy agreements could be automated. A smart contract for travel insurance can be automatically triggered once a flight is cancelled. Once the cancellation is posted, the smart contract makes a payment directly to the policyholder, thereby bypassing the claims process. Governments may use smart contracts to manage title recordings, social services, and e-voting. In manufacturing, smart contracts may replace current supply-chain processes such as bills of lading, proof of origin, or quality control. Another interesting application is tying smart contracts to the Internet of Things (i.e., cars, appliances, and devices). For example, a washing machine may contain a sensor indicating when it is low on detergent and then automatically reorder it.

One of the leading platforms for smart contracts is Ethereum, which was specifically designed to be a smart contracts platform. Although traditional cryptocurrencies, such as Bitcoin, can store and transfer value, Ethereum is also capable of carrying data in the form of arguments, which means that the platform can be programmed to take a specific action once certain conditions are met. Thus, contracts can be programmed to be self-executing because the platform can send money once the specified conditions are satisfied. Theoretically, given enough time, the platform will eventually be able to solve any computable problem. However, in practice, how well the platform runs depends upon network speed and memory.

Although many advances have been made in smart contract technology, it is still in an early development stage. There are issues such as scalability, centralization risk, and usability that must be addressed before mass adoption by the general public. The issue of scalability arises because the technology is dependent on network speed. More complex transactions require much higher network speed to which only some large entities have access. This may also lead to centralization risk if power is concentrated into a small number of hands. Such concentration means that a group of bad actors may conspire together to approve malicious transactions. Finally, these “smart contracts” are still primarily written in code and not easily readable by the average lawyer. Tools will have to be developed to bridge the usability gap.

In conclusion, as smart contract technology evolves, it will surely disrupt many industries. Major industries such as financial services, government, real estate, manufacturing, and healthcare have begun testing this new technology. It is only a matter of time before the technology is fully implemented. Lawyers can play an active role by staying abreast of changes that may affect their clients. Transactional lawyers may wish to learn more about the technical aspects of their future “smart contract” to ensure that it aligns with their client’s wishes and goals. In the future, litigation attorneys may no longer be litigating the “four-corners” of the contract, but rather expanding into the intent of the code.

Tsui S. Ng

Tsui S. Ng is an attorney at the New York City Department of Education. She specializes in administrative law and privacy compliance. She is a Business Law Fellow for the American Bar Association’s Business Law Section, and Vice Chair of the Cybersecurity Subcommittee of the Section’s Cyberspace Law Committee. Any opinions expressed are solely that of the author’s and do not express the views or opinions of her employer.