Confidence in Contracting and Cutting Transactional Costs, 0318 SCBJ, SC Lawyer, March 2018, #30
| Author | Mike Echternacht and Elsbeth Magilton, J. |
| Position | Vol. 29 Issue 5 Pg. 30 |
Why Attorneys Need to Pay Attention to the Rise of Blockchain Systems
Mike Echternacht and Elsbeth Magilton, J.
Attorneys are not generally known for our innovative uses of technology. This is probably a good thing. When client records are involved, taking a risk on new technology is not necessarily wise. The client’s business development strategies, however, are another story. Many clients want to understand the risks involved in developing or utilizing new technologies. For this reason, it is paramount that attorneys stay informed of new developments in the tech sector.
If you’ve been paying attention at all in the past five years, you’ve heard of bitcoin, the crypto-currency1 that took some online marketplaces by storm in 2009.2 It has since waxed and waned in popularity. Bitcoin and other digital currencies, meaning currencies in which encryption techniques are used to regulate units and exchanges, have yet to play a mainstream role in our national economy. Crypto-currency popularity aside, the rise of these currencies introduced us to a mechanism that is rapidly changing the marketplace: block-chain. Blockchain systems are being developed and distributed by an increasing number of financial companies and start-up ventures, but what exactly is a blockchain system?
What is blockchain and how does it work?
A blockchain is, at its core, a shared ledger. Think of it as a database taken up a notch. A block-chain database system accepts input from multiple users. It can only be changed with consensus from every user because its protocol3 forces every user’s data to match every other user’s data in order to record the transaction. Basically, the information is stored and shared by everyone and the automated process dictates that every server or node4, meaning a participant in the ledger, agrees. This means there is no one party in control of the ledger. With no central authority, the risks of fraud decrease dramatically to the point of non-existence.
A “block” is created when multiple nodes come to a consensus on a transaction and it is recorded to the ledger. Each block is time stamped and references the previous block using random assignment numbers, called a hash. This creates the “chain.” Blockchains can be public, like those utilized by bit-coin exchanges, or private. Private blockchain systems require permission to access the data. In a private blockchain the users are vetted by the network operator, but that operator may not independently edit the blockchain. A blockchain’s decentralized nature remains intact even when operated privately.
Still with us? Hang in there, because it gets better. The logic of traditional contracts can be programmed into a blockchain, allowing it to self-execute “smart contracts.” Smart contracts refer to contracts that can be executed and enforced without human interaction. Contract provisions can be programmed into a blockchain protocol. When a certain executing event takes place, the blockchain executes the contract provisions, automatically releasing funds or data. The idea is that smart contracts provide additional security above, beyond and even outside of traditional contract law, and drastically cut transactional costs.
This brings us to the two major themes driving the development of blockchain technology: (1) enhanced confidence in contracting and (2) cutting transactional costs. The next logical question is, then, what area of law could benefit from blockchain technology and what challenges does its implementation create?
What areas of law could the block-chain serve?
Banking and FinTech5 are ideal industries to utilize a secure, unalterable ledger. In fact, most if not all major financial institutions have invested time and resources into the development and deployment of blockchain technologies. Those institutions are looking at how to deal with exchange and acceptance of crypto-currencies, and also how public and private blockchains can function to reduce fraud and lower transaction costs. Blockchain applications are also springing up in any area that currently uses a centralized registration or processing system. Finally, platforms are also being developed to address transactions that are prone to “friction,” such as highly negotiated business and entertainment agreements or complicated real estate transactions.
If you’re a real estate attorney your ears may be perking up. A blockchain could be assigned to a single parcel. It could save clients thousands in insurance and other associated title research costs. Of course, there is the pre-blockchain history to consider. That background could be entered and verified by every party, then during later transactions parties can contract with confidence in the security of the blockchain verification. Another similar example may be wills and estates. A client and his or her attorney could enter each asset as a block. If at some point the client desires change, there would be no question of fraudulent changes, given that all parties have to agree to any changes in order for the block to be changed. The entire probate process could be programmed into a blockchain. Each asset would be distributed based on its set of instructions.
Additionally, highly regulated industries may find a blockchain ledger system beneficial. Say a defense contractor is establishing a system to track and record every export-controlled mechanism it produces and ships or receives from overseas. Using a blockchain ledger it would be virtually impossible for any actor to slip “tainted” goods into the recorded inventory. This application would apply to any highly regulated industry— from preventing the trade of blood diamonds to fair labor standards in the fashion industry.
It is likely there are legal applications for blockchain that no one has considered yet. The blockchain system is predicated on no party trusting any other party to act unilaterally. It creates trust in the absence of trust. In many facets of the law attorneys spend considerable time and financial resources avoiding fraud and creating confidence in contracting. The code behind a blockchain removes the human element of selfishness— even if someone wants to risk committing fraud they physically cannot. The security this...
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