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Bitcoin eroding away

How lawyers can can capitalize on smart contract revolution

Friday, July 02, 2021 @ 2:33 PM | By Sebastian Ferguson

LexisNexis® Research Solutions
Sebastian Ferguson %>
Sebastian Ferguson
The cumulative market cap of cryptocurrencies as an asset class grew around 300 per cent in 2020 to somewhere around $1.5 trillion, with bitcoin (BTC) leading the pack with a market cap of over $1 trillion. However, whilst it is true that BTC dictates and dominates the cryptocurrency market, it is crucial to distinguish BTC and cryptocurrencies themselves from blockchain as an underlying technology.

To understand what blockchain technology is, it is important to define its three core characteristics. Blockchain is:

  • A ledger: essentially a database of “blocks of information” on a chain secured through cryptography. Fundamentally, each block stores data on the history of custodianship, ownership and location of digital currency and other digital assets such as titles of ownership, IDs and contracts. That is also;

  • Publicly distributed: this essentially gives blockchain its security. The proof of work and proof of stake systems allow each alteration of data to be validated and subsequently recorded by all other nodes on the blockchain. And;

  • Decentralized: through the principle of mutual distrust, this aspect of the technology will revolutionize asset transfers. As an example, whereas a payment on a credit card would require validation by the bank, a payment on the blockchain would simply be validated by the data held across the blockchain. This also greatly reduces time and costs of transfers. 

As it stands, the greatest obstacle facing the transaction of assets is uncertainty. This is where blockchain can play a significant role. Blockchain can help with identity management, asset tracking and prevention of reneging on deals. The latter function is the most exciting aspect of blockchain technology and this is performed and guaranteed by way of smart contracts.

What are smart contracts?

The term smart contract was coined by Nick Szabo in 1997, long before BTC was created. Szabo defined smart contracts as computerized transaction protocols that execute terms of a contract. In simple terms, his goal was to use the distributed ledger to store and execute contracts. As smart contracts operate through the blockchain, they inherit some interesting properties which make them highly secure.

Firstly, all documents stored on the blockchain are duplicated multiple times and therefore originals can be easily restored.

Secondly, they are incredibly safe given that once they are created, they can never be altered (commonly referred to as immutability). The cryptography and public distribution make fraudulent tampering virtually impossible. Clearly, this also presents problems of inflexibility within itself.

Perhaps most importantly, smart contracts are self-executing once the conditions of the contract have been met. This massively reduces the time and cost of instructing transactional lawyers. This poses a potential threat for the future role of lawyers, which will be discussed later.

How do they work?

Smart contracts, once coded onto the blockchain network using programs such as Solidity, are able to self-authenticate that the terms of the contract have been met, then self-execute without the need of a central authority, legal system or enforcement agency. They are then finally updated as being executed on the blockchain.

The traditional vending machine anecdote is perhaps most useful in demonstrating how smart contracts operate in real life. Vending machines are programmed so that once a certain amount of money is put into the machine (buyer’s terms), the machine will dispense the specific snack or beverage to the purchaser (seller’s terms). There is no need for a shopkeeper to accept this offer. The vending machine self-executes the contract once the money is inserted and the button is pressed. Clearly, there is a huge potential to reduce time and costs associated with contracts.

Note, in this situation, through the addition of “oracles,” the vending machine could even detect when it is low on stock and send a signal to the manufacturer to restock the machine.

It should be noted that this actually does fit within the current understanding of contracts law across common law jurisdictions, given that the display of goods in the vending machine demonstrates an invitation to treat, pursuant to PHARMACEUTICAL SOCIETY OF GREAT BRITAIN v. BOOTS CASH CHEMISTS (SOUTHERN), LTD. (1953) 117 JP 132.

How can they be utilized?

  • DeFi (Decentralized Finance). DeFi is an umbrella term for a variety of blockchain-based financial applications which aim to mitigate the necessity of banks for transactions of value. Peer-to-peer lending cryptocurrencies have grown exponentially over the course of the pandemic, but decentralized exchanges such as BTC even more so, given that BTC is touted as the new “hedge against inflation,” replacing gold. This has been particularly true across South America, with El Salvador being the first country to accept BTC as legal tender.

  • Insurance. An example of how smart contracts could be used is through agricultural, parametric insurance. For example, a smart contract could be coded so that each time the temperature reaches freezing point or below, the insurance company must pay the corn farmer X amount of money for the destroyed crops (even if they weren’t actually destroyed). This kind of setup would again be facilitated by an oracle solution such as Chainlink which would provide the temperature data. Clearly, this could have a huge impact on the insurance industry and particularly for insurance litigators.

  • Supply chains. Blockchain has the capacity to radically transform supply chains by providing unrivalled clarity from start to finish. Vechain is a project which aims to do just that. Through the blockchain, products, especially food, can be tracked across their entire life to see who and how they have been handled. This has huge implications for food ensuring food safety regulations. For example, if an attached sensor detects that sushi goes warm, it could flag on the package’s QR code, that it was stored above recommended temperature when being shipped. Further, this could eradicate the possibility of child labour that has recently been witnessed within Mars, Nestlé and Hershey. Blockchain could even help in enforcing environmental regulations, a globally urgent issue.  

This is the first half of a two-part series. 

Sebastian Ferguson is a law postgraduate currently working as a paralegal in the U.K. with a keen interest in commercial law, banking and finance. Contact him via LinkedIn.

Photo credit /  DoggieMonkey ISTOCKPHOTO.COM

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