The Use: Smart Contracts
Here’s a familiar scene in the world of finance: A borrower looks to a lender for capital, and the lender wants security before it extends the credit. The options for collateral are numerous: hard assets, accounts receivable, securities, real property, cash—the list goes on and on. Then the lender perfects its security—maybe through recording a lien instrument or filing a Uniform Commerical Code (UCC) financing statement—and must then undertake the obligation to police its collateral, service the loan, and enforce any defaults. All of these processes come at a cost.
This is where blockchain-based contracts—known as smart contracts—can help. A smart contract is simply a program on a blockchain that is automatically set to execute when certain predetermined conditions are met. Let’s take our lending example above. Assume the borrower agrees to place collateral in the form of a digital asset in a digital wallet or account controlled by the lender, who agrees to originate the loan once the collateral is in place. Under the newly proposed UCC Article 12, which I will explore in more detail in a subsequent article, the lender will have a perfected interest in its security upon receipt of the security—without having to file a separate financing statement. A smart contract can be programmed to automatically fund the loan once the collateral is in place; immediately sweep the collateral upon a default, such as a missed balloon payment; or, upon full repayment of the loan, release the collateral back to the borrower. Funding, perfection, and enforcement can thus happen seamlessly and at a reduced cost. And because the blockchain is a digital ledger, the transactions are automatically booked, verified, and recorded.
Take another common transaction: buying and selling a home. When it comes time to close, the parties show up in person to sign a host of documents. At the same time, the buyer and its lender, if the buyer is using financing, wire the sale funds to an intermediary, such as a title company, who holds the money for distribution. The parties then physically sign all documents, including deeds and mortgages, which must be recorded. Once the sale funds are confirmed in receipt, the title company distributes them—and, typically, takes a fee for its efforts.
Aside from creating costs, these processes—especially recording of mortgages and deeds—take time. During the pandemic, delays in recording deeds have stretched to a year or more in some places. In a world where a party’s unclouded title to real property depends upon prompt recording, delays increase risk. Smart contracts can help. All of the facets of a home closing could be programmed to execute as soon as a precondition is met. For example, once the buyer and its lender deliver the sale funds to predetermined digital wallet, a smart contract could immediately distribute the proceeds to the seller, the real estate agents, and any other party receiving payment from the sale. Just as importantly, a smart contract could immediately distribute the property’s digitized deeds and mortgages, without the need for wet-ink execution, to the buyer, the mortgage company, and the local clerk for near-real-time recording.
Additional uses for smart contracts abound. Delaware has expressly allowed corporations to utilize the blockchain and smart contracts to disseminate stock ledgers and shareholder communications and automate certain corporate processes, such as voting on corporate measures. Smart contracts have also been deployed to streamline supply-chain processes and resolve vendor disputes. And smart contracts have been posited as a way to help better secure and share patient medical records, increasing patient privacy protections while potentially reducing the legal risk associated with data breaches.
The Use: Authenticating Evidence
Every litigator, looking ahead to a trial and considering its evidence, has had some version of this thought: How do we get this admitted? Authenticity and chain of custody are two key concerns underlying this question. The blockchain can help alleviate them. Thanks to the blockchain’s design, any data stored on it comes with a built-in record of all of the preceding transactions that led the record to its present custodian. Chain of custody is thus automatic. And because a well-secured blockchain-based network is distributed among many users, records or transactions cannot be altered without the network as a whole rejecting the change as being out of line with the consensus’s records. Authenticity, too, becomes more concrete. These features also aid in laying the foundation for the familiar business-records hearsay exception:
- Was the record created at or near of the time of the events described?
- Was the record kept in the ordinary course of business, and was it the ordinary practice of the business to keep such a record?
The blockchain can make the answer to these questions clear and ease admission of evidence.
The Use: Proving Ownership with NFTs
The legal world loves its paper. Ownership passes and is evidenced through a paper deed or other title document that’s inked, stamped, and kept in a physical repository. But as noted above, this antiquated system poses its own risks: delay, added costs, and vulnerability to alteration and hacking. The blockchain—and, specifically, non-fungible tokens, or NFTs—disrupts these old methods. Despite their place in the popular consciousness as simply pricey digital pictures of apes, NFTs are a versatile and powerful way to demonstrate ownership. In a nutshell, an NFT is a unique—i.e., noninterchangeable—token, or piece of code, that lives on a blockchain and is assigned, or linked to, a particular asset to demonstrate title. The NFT represents the value of the tangible or intangible asset to which it’s linked. Once created, the token itself can be transferred and stored in the same way as any other data or digital assets on a blockchain. This not only facilitates transactions but creates irrefutable proof of ownership, without the need for paper records. Beyond evidencing transfers of artwork, NFTs can be used to distribute stock or other ownership interests in a business entity, demonstrate title to real and personal property, and delineate a buyer’s rights—from ownership to copyright—in a particular work.
In sum, while cryptocurrency is the most famous example of a blockchain’s use, it’s far from its only utility. The blockchain’s versatility has the ability to vastly improve and transform many of the elements and tasks that have become common to the legal world—and, along with that transformation, move firms and their clients toward their ever-present goal of saving time and money.