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Blockchain and the Future of Smart Contracts

Nina Lukina

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This article by Nina Lukina first appeared in the New York State Bar Association Journal, June 2018, published by the New York State Bar Association, One Elk Street, Albany, NY 12207.

What is blockchain?

You may have heard that blockchain technology is about to “disrupt” industries as diverse as music, banking, automotive engineering, and law. For those who have not dabbled in Bitcoin trading, how exactly it will do this is obscure. What is blockchain, aside from a buzzword, and how does it intersect with the legal profession?

Blockchain’s origins are in virtual currency. It is the technology that underlies the trading of recently invented money like Bitcoin, giving it value. Often described as a “ledger” that logs transactions and ownership, blockchain fills the role traditionally held by a centralized bank. Unlike a bank, however, blockchain is decentralized. Rather than residing with one trusted third party, this database is spread among nodes in a network. Each device running a virtual currency app is a node in that currency’s blockchain. There is no single copy of the database; it is distributed globally and verified at each point (or block of the chain) with cryptography, a system that enthusiasts say is not only tamper-proof, but can also replace traditional intermediaries like centralized banks.

“Smart Contracts”

Though blockchain’s history is tied with Bitcoin, a highly voluble currency and possible fad, as well as with shady activities like purchasing drugs anonymously online, its potential extends far beyond its early uses.

In a recent New Yorker profile of Bitcoin investor Michael Novogratz, Gary Shteyngart writes:

What can you do with blockchain besides buying drugs on the dark Web? Potentially, quite a lot. A ledger kept among a vast number of computers can transfer money more securely than traditional banks, and, possibly, faster, all the while denying Wells Fargo, say, a cut of the transaction. But that is only the start. Ethereum’s platform, for example, can work as a lawyer-free contract database dealing with everything from property sales to estate transfers.

Ethereum is a blockchain organization that also mints its own cryptocurrency, called Ether. But Ethereum aims to apply blockchain to much more. Its website describes it as a “decentralized platform that runs smart contracts” and encourages developers to “store registries of debts or promises, move funds in accordance with instructions given long in the past (like a will or a futures contract) and many other things that have not been invented yet, all without a middleman or counterparty risk.”

Blockchain-based contracts could be created and even carried out without human involvement, with the cryptography algorithm minimizing the possibility for fraud and errors. Ujo, a music startup built on Ethereum’s blockchain, aims to make recording contracts as we know them obsolete, thereby giving more control to artists over the distribution and pricing of their music, control they have largely lost since the invention of Napster and the advent of streaming. Musicians would no longer have to register copyrights or go through a record label to release and collect payment for their work.

In an illustration of how blockchain can facilitate lawyer-less contract creation and registration of intellectual property, singer-songwriter Imogen Heap was among the first to release a song on Ujo, entrusting all credits and licensing to the blockchain. Listeners and other musicians who may want to remix the track can purchase the song directly from the artist with Ether. Imogen Heap is paid immediately, and her song is embedded with a unique code, or “hashed,” to prevent its illegal distribution.

Similarly, programs can be built on the blockchain ledger’s hashing to replace legal records and services that provide authentication and transactional history, such as proof of title, chain of custody, property ownership, notarization, and escrow enforcement.

Platforms like Ujo and Ethereum promise to cut out the middleman, giving the parties involved more control and saving them money on fees. In my research, this part puzzled me. Aren’t these companies themselves just a new sort of intermediary? In a January 16, 2018 New York Times article called, “Beyond the Bitcoin Bubble,” Steven Johnson wrote of Ethereum, “[n]o one owns it.” Ethereum, originally developed by a Swiss nonprofit called The Ethereum Foundation, is open-source and democratically run by enthusiasts worldwide. It seems that, so far, there has been no evidence of one corporation or individual gaining too much influence over the blockchain.

Confronting Challenges: The Future of Blockchain

Will blockchain end up like, say, Google Glass, a technology we hear about until we don’t, or will its potential actually come to fruition? The latter did occur with Big Data, after all, which went from buzzword to the unprecedentedly powerful technology behind the Facebook campaign-influence scandal. The answer depends, in part, on whether blockchain can evolve and overcome certain concerns and flaws.

One question is how “smart contracts” will interact with local and cross-border jurisdiction. Such contracts are, at least currently, outside the law. Which data privacy laws will apply? And what about taxes? A 2016 report by the International Monetary Fund titled “Virtual Currencies and Beyond: Initial Considerations,” states that virtual currencies have “a high potential as a means for tax evasion” due to the anonymity that blockchain provides.

This anonymity (which some early users of blockchain have capitalized on to conduct illicit transactions) extends to your name. In another way, blockchain is highly transparent. In the case of Bitcoins, for example, you can see how many are in anyone’s account and trace transaction histories. Theoretically, if you sign a smart contract with someone, that person will be able to see more information about you and your activities than you might want. Would you want someone who sends you some money for a shared cab, for instance, to see your bank account and purchase history? It is still early yet in the blockchain game, and such problems are still being worked out.

Scalability, or sustainable growth, is another issue that will have to be confronted if blockchain and smart contracts take off. For your cell phone or laptop to serve as a node in the blockchain, it would have to hold the records of all transactions ever, a large, rapidly growing database that demands a great deal of computing resources. Bitcoin traders say it currently takes days to download the Bitcoin database. Alternatively, you can skip this part and just get the client application. As more people opt out of downloading the whole database, as many Bitcoin traders do, the blockchain becomes more concentrated in fewer places and could therefore be more vulnerable to tampering.

Still, the Bitcoin blockchain has never been hacked, despite the high incentive for infiltrating this billion-dollar business. The Bitcoin example suggests that blockchain can promise tight security in a time when data breaches have spiraled out of control.

More challenges will undoubtedly arise as the technology evolves. Other uses will reveal themselves too, as more industries investigate blockchain. Keen on not being left behind in a blockchain revolution, many banks are actively exploring ways to use blockchain to their benefit. Santander was the first bank to launch a payment app based on blockchain. In May 2018, J.P Morgan applied for a blockchain-payment patent. Also in May, the automakers BMW, Ford, GM, and Renault announced the formation of the Mobility Open Blockchain Initiative to investigate its uses in driving.

Meanwhile, in law, big firms like Perkins Coie and Goodwin Procter have started blockchain practice groups. The document management system NetDocuments has completed a proof-of-concept integrating its cloud platform with blockchain. There does not seem to be widespread use of smart contracts or hashing of intellectual property, yet. The next few years will reveal more about how blockchain will affect licensing and contract work. If everything its proponents say proves to be true, its impact on the industry will be significant.