This article is written by Somadatta Bandyopadhyay who is pursuing a Diploma in Cyber Law, FinTech Regulations and Technology Contracts from LawSikho.
Table of Contents
Introduction
Blockchain as a technology has gained momentum over the last few years. One because of its nature and all the advantages it comes along with, second, because it has piqued the curiosity of people who want to know more about it but do not know where to start from given the plethora of information available all around.
Amidst all the uproar and confusion regarding blockchain, laymen have made the word synonymous with cryptocurrency. But it is pertinent to understand that those are two very different things. This article will breakdown blockchain as a technology and the application it finds in cryptocurrencies and smart contracts.
What is blockchain?
Blockchain is a decentralized, immutable, Distributed Ledger Technology (“DLT”). Since it boils down to be a ledger, it is a technology that enables recording of transactions that happen over the network. The transaction can involve both tangible assets, like land, cash etc., as well as intangible assets like intellectual property. The question that arises is: where does blockchain fit in for transactions and why are people resorting to it more.
The biggest advantage of blockchain comes with the fact that it is decentralized or that there is no central regulatory authority to regulate or supervise transactions, which is what happens with financial data where the entire world depends on their respective central intermediaries. Therefore, if there is a transaction that needs to be done, the waiting time is significantly reduced as there is no intermediate regulatory authority approving the transaction as well as the parties to the transaction would not have to wait for business hours or business days to proceed with the transaction. It is also able to store records of ownership of assets without the need for a centralized record-keeping mechanism. Any changes in ownership of assets or “transactions” are also recorded in an immutable, non-repudiable manner. This technology forms the basis and finds its application in cryptocurrencies and smart contracts.
How does a transaction take place in blockchain?
In essence, blockchain is a Peer-to-Peer (P2P) network system. It consists of several independent computer systems called “nodes”. Transactions on a blockchain have to be authenticated. Each user on a blockchain has two key associated with it which help in the authentication process – a private key, private to the user only and a public key , which is open for use for all. These keys are nothing but a string of data, a combination of alphabets and numbers that identifies a user. The transactions are unlocked or allowed to take place between the users by the blockchain by way of these keys and a supporting algorithm.
When these transactions are successfully completed, they have to be grouped together in “blocks”. Now whether these “blocks” are valid enough to be added to the whole chain of blocked transactions is something that has to be validated by the nodes, who are called “miners” in this case. This means that the majority of “nodes” must agree that the transaction is valid in order for it to be added to the chain. The people who own the computers in the network are incentivized to verify transactions through rewards. This process is known as ‘proof of work’.
What is a smart contract?
Among other things, one area where blockchain finds application is “smart contracts”. Smart contracts, in essence, are analogous to the contracts we know of in the non-virtual space. It is based on a set of promises that are agreed to by parties on the meeting of minds. The terms of the contract will have to be negotiated by the parties, if there is no consensus that they can reach with the initial terms. There are obligations that ensue from the contract based on the doing or not doing of the terms.
Smart contracts are based on the exact same theory except that the terms of the contract are executed automatically by computer transaction protocols if a certain set of conditions are satisfied. The terms of the contract are translated into computer syntax that follow “if-then” conditions which means “if” a certain condition is satisfied, “then” the terms can be executed. This code is embedded on a Distributed Ledger Technology system. The execution of the terms of the contract are supervised and maintained by the nodes of the DLT.
Because of the nature of smart contracts being self-executing without the need for human intervention, it could bring about a massive revolution in the finance industry by dramatically reducing the costs for financial institutions. These institutions require verification and identification of their clients to check compliances with Anti Money Laundering laws and regulations. This “Know Your Customer” or KYC process is not only tedious but also not cost-efficient. This entire process can be replaced by smart contracts whereby the lenders can automatically carry out the process of checking and verification. Also, since a DLT acts as an immutable history of records, it is possible to keep track of spending patterns of every client and cherry-pick if there has been a questionable pattern in case of any because of engaging in questionable activities.
Another use case of smart contracts being employed in the financial industry would be releasing money to borrowers once something is mortgaged or pledged or used as a collateral. This would involve slightly more complications because there would be a lot of monitoring and compliances involved. Whether the borrower is the owner of the collateral and also whether the collateral is registered if it is land or real estate. If the conditions are met, the financing proceeds would be transferred automatically to the borrower. A regular check would also be required to ensure that the borrower is employed as well as maintains a credit score level.
DLT platforms within the financial industry, CORDA and Ethereum, are embedding smart contracts within their infrastructure.
Will smart contracts replace lawyers?
Where do lawyers find their space in such complex technologies? Also, do the inception of smart contracts and their applications mean that lawyers would be replaced?
Not entirely. But if smart contracts are readily put into practice, the role of lawyers would definitely change, to the extent of being reduced in certain commercial transactions. There wouldn’t be any requirement or very less intervention in the registration and transfer of assets, verification whether the conditions precedent are completed or not, monitoring compliances, among other things that can be replaced by computer code.
However, challenges could come up when it comes to exactly replicating a well drafted contract by a lawyer to a technical computer code. The process would have to be seamless and standardized. Since certain kinds of contracts are very heavily negotiated, there could arise problems when it comes to putting it down in code form.
Another challenging premise would be which and how much of a legal contract can be replaced by smart contracts. It would most definitely depend on how complex the transaction being represented is. If it is a bipartite and well-defined agreement then it would be entirely replaceable by a computer code. However, when it comes to complicated commercial transactions, it is prerequisite that the contract is read into and split into portions which can be articulated using computer code and portions which require the human intellect and should be left to traditional legal wording.
For example, for a borrower looking forward to receiving an amount, an assessment of their credit score would be done from a credit rating agency. Depending on the rating received, the loan pricing would also move to a certain level. These kinds of scenarios which are contingent on certain conditions can be coded and made a part of the credit agreement and be documented as a smart contract. But again, a typical credit agreement more often than not has provisions which include relating to “reasonableness,” “material adverse effect,” “best efforts” etc. which are very nuanced and would require negotiations that would be very difficult to put in terms of computer code.
Therefore, smart contracts will definitely escalate the incremental evolution of the legal industry but will not completely replace it.
Other than smart contracts, since blockchain is a record keeping technology, it can find use in various fields like allowing corporations to list shareholders and other corporate records on the blockchain, to the document heavy criminal justice system whereby records created by blockchain could be shared among all the players in the system, from law enforcement officers to parole officers. Interested members of the public, such as victims, could keep abreast of the status of defendants. Blockchain can find application even in the world of Intellectual Property, especially copyright and the bundle of rights that come along with it. Blockchain can provide evidence of creation, first use, and rights management. Blockchain can track distribution.
Basically, any field that would require maintenance of documents, records and agreement will have blockchain as a resort.
Conclusion
Blockchain technology is the most transformative technology to emerge since the advent of the Internet. Going forward, lawyers will need to pay heed to the details of the technology adopted by the industries, which will include a hybrid model containing traditional as well as smart contracts. It is pertinent that lawyers stay abreast of the emerging technologies and also have the bare minimum knowledge about the coding that goes into these technologies to understand them better. This would ensure greater compliance, smoother system runs, more efficiency and negligible breaches.
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