Smart Contracts and the Limits of Computerized Commerce

Publication year2021
CitationVol. 99

99 Nebraska L. Rev. 330. Smart Contracts and the Limits of Computerized Commerce

Smart Contracts and the Limits of Computerized Commerce


Eric D. Chason [*]


TABLE OF CONTENTS


I. Introduction .......................................... 331


II. Bitcoin and Simple Transfers .......................... 333
A. Digital Currency as Computer Data ............... 333
B. Problems with Centralized Digital Currency ....... 334
1. Introduction ................................... 334
2. Regulatory Oversight .......................... 335
3. Trust .......................................... 337
C. Bitcoin and Decentralization ....................... 338
D. Bitcoin as a Remote Computer ..................... 341


III. Ethereum and Smart Contracts ....................... 342
A. Bitcoin Smart Contracts as Locks .................. 342
B. Limits of Bitcoin Smart Contracts ................. 345
1. Variable-Payment Contracts ................... 345
2. Malicious "Looping" Contracts ................. 347
3. Economically Useful "Looping" Contracts ....... 347
C. Ethereum Smart Contracts ........................ 349
1. Introduction ................................... 349
2. A Smart Ponzi Contract ....................... 351
3. Lotteries and Other Games .................... 352


IV. How Ethereum Interacts with the "Real World" ........ 354
A. Oracles ........................................... 354
1. Interest-Rate Swap Example ................... 354
2. Implementing the Swap in Ethereum .......... 356
3. External Information and Oracles .............. 359
4. Evaluating the Interest-Rate Swap Example . . . 361
B. Tokens ............................................ 363
1. Introduction ................................... 363
2. Utility Tokens ................................. 364
3. Equity Tokens ................................. 365
C. Summary ......................................... 367


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V. A Remote-Computer Model ............................ 368
A. Ethereum as a Computer .......................... 368
B. Ethereum as a Remote Computer .................. 370
C. Legal Significance of the Remote-Computer Model . 371


VI. Conclusion ............................................ 373


I. INTRODUCTION

Having recently celebrated its ten-year anniversary, Bitcoin should be considered a qualified success. In October 2020, each unit [1] was worth about $10,700, and the entire market capitalization was approximately $200 billion. [2] Bitcoin is a significant economic force with sizable market value. Despite this success, however, Bitcoin has not been widely adopted as a method of payment, which was its intended use. [3]

By providing a template for a durable cryptocurrency, Bitcoin also blazed a path for other cryptocurrency projects. In terms of market capitalization and current importance, Ethereum is comfortably in second place. [4] In October 2020, it had a market capitalization of approximately $40 billion. [5] Unlike Bitcoin, however, Ethereum was not designed primarily to serve as a method of payment. Ethereum supports a system of sophisticated "smart contracts" that would not work on the Bitcoin system.

Smart contracts and cryptocurrencies have sparked considerable interest among legal scholars in recent years, and a growing body of scholarship focuses on whether smart contracts and cryptocurrencies

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can sidestep law and regulation altogether. [6] Bitcoin is famously decentralized, without any central actor controlling the system. Its users remain largely anonymous, using alphanumeric addresses instead of legal names. Ethereum shares these traits and also supports smart contracts that can automate the transfer of the Ethereum cryptocurrency (known as ether). Ethereum also supports specialized "tokens" that can be tied to the ownership of assets, goods, and services that exist completely outside of the Ethereum blockchain.

The goal of this Article is to evaluate the degree to which cryptocurrencies and smart contracts can operate outside the reach of law and regulation. By some accounts, cryptocurrencies and smart contracts will revolutionize private law. [7] Some argue they have the potential to displace contract and property law. For example, in a previous article, I argued that Bitcoin represents a system of private property that exists wholly outside of traditional legal structures. [8] In this Article, I will argue that a complete revolution is not inexorable. [9] Facing the technical and complicated nature of this subject, we should keep in mind a simple fact: cryptocurrencies and smart contracts are computer data and computer programs. To a large extent, they will have legal force only if given force by judges, regulators, and legislators.

Part II describes Bitcoin and how it creates a system of property that exists outside of legal structures. Bitcoin is special because it controls no external assets (like securities, dollars, or gold). It is purely "notional" property that exists only on a computer file.

Part III describes Ethereum and how it builds upon the principles of Bitcoin. The primary innovation of Ethereum is smart contracts, which allow for variable and conditional transfers of cryptocurrency.

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To be of commercial value, however, smart contracts must incorporate economic or financial information (e.g., interest rates or exchange rates). Ethereum allows users to incorporate this information using third party "oracles." While oracles allow for sophisticated transactions, their presence illustrates some of the limits of smart contracts.

Part IV extends the discussion of Ethereum and explains how many developers use it as a way to effectuate property transactions. Tokens are specialized smart contracts used to represent ownership of assets or certain privileges. Conceivably, ownership in any asset- homes, cars, etc.-could be represented by Ethereum tokens. Rather than using a deed of transfer, owners could simply transfer the representative tokens.

Part V develops what this Article calls a "remote-computer model" of Bitcoin and Ethereum. Because Bitcoin and Ethereum are computer programs and computer data, we can view each as constituting a single computer. This hypothetical computer is remote in the sense that judges, regulators, and legislators can exercise little control over it directly. The remote computer controls ownership of cryptocurrency units, leaving direct cryptocurrency transactions outside the scope of traditional legal institutions. That being said, smart contracts often purport to control external resources and rights. For example, a smart contract might purport to control the transfer of land or stock in a corporation. These transactions have effects outside the hypothetical remote computer and can potentially be subject to control by legal institutions.

II. BITCOIN AND SIMPLE TRANSFERS

A. Digital Currency as Computer Data

Cryptocurrency units are essentially computer data. In Bitcoin, the total units of circulating bitcoin are collectively referred to as unspent transaction output (or UTXO). [10] In rough terms, UTXO associates bitcoin units with owners. Ownership of bitcoin is not, however, personal to individuals, corporations, or the other legal actors. Instead, ownership is determined cryptographically, typically by controlling a "private key" that "function[s] like a password." [11] If Alice owns one unit of bitcoin, it is because she controls the private key associated with that unit.

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In most Bitcoin transactions, the transferor sends the units of bitcoin to the "address" of the recipient. [12] We can imagine this address as being like an account number. Each address, in turn, has an associated private key, which we can imagine as being like a password. Anyone who knows the private key can, within the Bitcoin system, transfer the associated bitcoin units to another address. So, in more precise terms, UTXO associates bitcoin units with addresses, which users control with private keys.

For purposes of this Article, the cryptographic details have lesser importance. What is important, however, is that bitcoin ownership is reflected in computer data and cryptographic control. Bitcoin is not backed up by external securities, cash, or other investments. And, by design, bitcoin ownership is not enforced by courts or other legal actors. For reasons discussed below, [13] courts and other legal actors find it difficult or impossible to deal directly with Bitcoin, Ethereum, and many other cryptocurrencies.

To explain this difficulty, this Article will develop a legal model of cryptocurrencies based on a single hypothetical computer. [14] This hypothetical computer holds the history of all prior transactions (known as the blockchain) from which one can readily derive current ownership (or UTXO). Importantly, this hypothetical computer is legally "remote," meaning that judges, regulators, and legislators cannot alter the data and programs held on the computer. The remote-computer model will give us (as legal observers) a way to understand how the law can and cannot...

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