A LAWYER'S DIVORCE: WILL DECENTRALIZED LEDGERS AND SMART CONTRACTS SUCCEED IN CUTTING OUT THE MIDDLEMAN?

Author:Young, Charlotte R.
 
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INTRODUCTION

Society is progressing at a rapid pace. As math and science evolve, new technologies begin to utilize these advances and create something novel. These technological changes are revolutionizing not only the science-oriented industries, but also the humanities. One such example falls within the legal arena. More specifically, the exciting advent of smart contracts and their use of technological changes are altering the way law is processed and practiced. (1) However, as is often the case, new technological innovations spur certain growing pains. The implementation of smart contracts is proving no different.

Some view the smart contract as the start of a more ideal society. (2) With the aid of smart contracts and blockchain technology, machines can finally be equipped to fulfill some of the most basic human functions. (3) Not only would business transactions always occur in a timely, seamless, and cost-effective manner, but also more mundane life tasks, such as ordering laundry detergent, (4) could soon be done via smart contract technology. As exciting as these changes may be, smart contracts and the blockchain technology behind them are still immature. (5) Before this legal phenomenon is widely accepted, there needs to be more advancement in not only the code that creates the technology, but also in the law and its regulations. (6) As it stands today, smart contracts are most likely to be accepted only in part, and heavily tailored to meet each contracting party's needs.

This Note will start by giving an overview of the technology needed to implement smart contracts--blockchain technology (7)--and an explanation of how smart contracts fit within the framework of a blockchain. Next, this Note will discuss some of the major issues smart contracts face. Such issues include: the need to translate natural language into computer code, the traditional concept of contracting in conjunction with the effect of smart contracts on traditional legal notions, and reoccurring enforcement issues. After discussing smart contracts and the current issues barring wide-spread acceptance, this Note will explore the future of smart contracts in the legal arena by analogizing such an electronic contracting change to the now-widely accepted electronic clickwrap agreements. Additionally, this Note will explore recently enacted state statutes that create favorable legal conditions for smart contracts and what impact, if any, these statutes may have upon federal legislation. Furthermore, this Note will analyze the lack of and potential need for regulations regarding smart contracts. In an attempt to make smart contracts acceptable, this Note will suggest future regulations focus on two components of smart contracts. As it will be discussed, regulations should require smart contracts to utilize a permissioned ledger and focus on ensuring the legal requirement of mutuality between the two contracting parties. Lastly, this Note will conclude that although the publicity surrounding smart contracts is exciting and innovative, this form of contracting is likely to remain in a controlled business environment with implementation under select circumstances.

  1. OVERVIEW OF THE TECHNOLOGY

    1. What is a smart contract?

      There is no universally accepted definition of a smart contract. (8) In the mid-1990s, the general concept of a smart contract was broadly construed. (9) For this reason, the smart contract can hold a variety of nuanced meanings. (10)

      Nick Szabo, widely recognized as the creator of the smart contract concept, (11) defined a smart contract as "a set of promises, specified in digital form, including protocols within which the parties perform on these promises." (12) The key focus in this definition is on the idea of new technology. For widespread use, Szabo believed that smart contracts needed to be embedded within the world. (13) In order to embed these smart contracts, Szabo suggested placing contractual clauses within everyday pieces of hardware, such as cars. (14) This could be done by designing a smart contract that utilized computer software to decipher the contract's parameters. The computer software would only allow a smart contract to be executed if the initial input conditions were met. (15) For this reason, a smart contract is comprised of simple "if, then" contractual clauses written into whatever technological platform is used to complete the transaction. (16) Szabo recognized that contractual breaches were a major issue impeding the advancement of business transactions. Therefore, the goal behind a smart contract was to embed, within the software and hardware, contractual clauses that make it difficult and expensive for a party to breach the agreement. (17) Because of the novel technology used to create a smart contract, Szabo considered smart contracts more advanced than their "inanimate paper-based ancestors." (18)

      Although the smart contract concept can have many different definitions, Szabo's ideas spurred scholarship that eventually reached a consensus regarding key characteristics of any smart contract. For one, a smart contract is always in digital form and contains embedded contractual clauses. (19) Normally, these contractual clauses are written in the form of computer code. Additionally, the performance of a smart contract is always mediated by technology. (20) This means that payments and other actions within the contractual clauses are governed by rules-based operations on technological platforms. Essentially, there is no longer a need for the middleman. Furthermore, smart contracts are meant to be irrevocable. (21) Once a stipulated condition is met, the performance encoded within the smart contract cannot be stopped. (22)

    2. How Blockchain and Smart Contracts Coexist

      The recent invention of specialized technology has made smart contracts possible. (23) However, this was not always the case. Szabo's concept of smart contracts remained in the beta stage from the mid-1990s until the invention of the first digital coin, Bitcoin, in 2008. (24) The growing interest in Bitcoin and the technology on which it was built--blockchain--ignited numerous research and development projects regarding its practical application. (25)

      Blockchain is the checking mechanism that facilitates and verifies transactions. Because of its versatility, blockchain can easily be adapted to verify any transaction, so long as it is translated into computer code. Two key features of smart contracts include automation and self-regulation via technology. (26) Smart contracts were able to obtain these features through the use of blockchain. Because blockchain acts as a checking mechanism, this self-regulation removes the human element, commonly referred to as the middleman. This removal has the benefit of streamlining the contracting process, lowering the likelihood of human error, and creating a more cost-effective option. (27)

      Assuming all preliminary conditions are met, the machine using a smart contract will ensure performance on the contract's terms. (28) However, just like in traditional contracting, the initial terms of a smart contract must be interpreted and verified. (29) In traditional contracting, this is done by a human or, in some cases, a judge. Unlike traditional contracting, smart contracts utilize the third-party computer-based process, blockchain, to verify the occurrence of a contract's terms. (30)

    3. A General Discussion on Blockchain Technology

      As mentioned above, blockchain is a necessity for any smart contract. For that reason, this Note requires a brief discussion on the technology and how it operates.

      Blockchain contains a decentralized ledger that anonymously tracks and creates a record of transactions pertaining to that ledger. (31) A block is created for each transaction. The ledger is responsible for containing a complete and continuous record (the "chain") of all transactions. (32) Each transaction equates to a "block;" however, these blocks are only added to the blockchain if the "nodes" reach a consensus that the block (the transaction) is valid. (33)

      One of the most notable features of a blockchain is its ability to exist simultaneously across a network of computers. (34) In order to record and check the accuracy of each transaction within the blockchain, the ledger must be replicated and distributed among multiple parties. (35) These parties, commonly referred to as "nodes," (36) are often anonymous third-party members of the blockchain network. (37) The process of checking a transaction's validity requires a high level of computing power: "'miner' nodes compete with each other to solve a highly complex algorithm'" (38) which, if proven, will verify the transaction's validity. (39) The first miner node to solve the algorithm, thus verifying the transaction's validity, is rewarded. (40) Each block usually contains the following four pieces of information: a "hash" from the previous block, a summary of the actual transaction, a time stamp, and the verification of the transaction. (41)

      Additionally, the blockchain network is decentralized, which has the primary benefit of making the technology hard to hack by eliminating the one centralized point of vulnerability. (42) Because blockchain lacks a centralized point, the ledger needs to be self-maintaining. (43) This is possible, in part, because each block contains the hash of the previous block. (44) This means that each current block is tied to the previous one, making any attempt by hackers to alter the transaction post-validation easily detected. (45) Despite the lack of diversity in terms of a technological platform, a party to a smart contract still maintains choices regarding the design of the blockchain technology. Smart contracts can utilize a permissionless or permissioned ledger, or a hybrid of the two. (46) A permissionless distributed ledger allows anyone "to download the software, submit messages for processing and/or be involved...

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