Contracts are Breaking Smart

The world is filled with 3% processing fees, $200 billable hours, long queues that wrap around themselves, and mountains of red tape in notary stamps and filling out government forms in triplicate. These inconveniences are always chalked up as “the cost of doing business.” This phrase always rubbed me the wrong way as if there were no other possible way in the conceivable universe that a desired end can be reached without suffering this string of disruptions.

So what if we could provide a better answer than these depressing 5 words? What if we no longer even asked why things have to be done this way or that way? What if we present an alternative so obviously superior that the old world ends not with a bang, not even with a whimper?

There are exciting new developments happening in the world of contracts (I’m not sure that’s ever been said by a truth-telling person). While they aren’t as radical as their supporters might lead you to believe, that may actually be a good thing.

The nature of contracts will not — maybe ever — change. Person A wants to exchange goods or services with Person B. Contracts developed as a way to allow A and B to make an exchange without immediately handing over the goods or performing the services while still holding the other person responsible under threat of greater costs for breaking the agreement. But through time, as technology progresses and people find new ways of cheating, more and more problems arise encouraging citizens to demand protection from the government. To provide security to contracting parties, governments centralized control over the contracting process. The common law (found in most former British colonies) and civil law systems (found most everywhere else) developed different procedures to achieve this objective, including, but not limited to, notaries, trials, arbitration, and mediation — all of which take time and often a big chunk of money.

Law, especially contract and property law, has long been shrouded with a certain mist of confusion. The precision and specificity required to write an agreement that both parties can assent to, while being understood by objective third parties in the case of a dispute, can be quite cumbersome to understand for a lay person unfamiliar with the nature and extent of legal jargon (see what I mean?). Because of this technical nature, the legal system has justified its own existence for hundreds of years by entrenching its necessity in its incomprehensibility to the “uninitiated.”

Enter Smart Contracts

In a world that is being eaten by software and, consequentially, is breaking smart (see breakingsmart.com), it was only a matter of time until this phenomenon would reach the legal industry. But it took a computer science breakthrough to catalyze this shift towards cheaper, more secure, and automated creation and execution of agreements. But what is a smart contract and what does it do?

Smart contracts are agreements governed by blockchain technology that self-execute the terms of an agreement in reaction to what happens in the physical world.

Smart contracts are here to provide relief, alleviating pain in terms of financial costs, time wasted, theft, and general peace of mind in the following ways:

  1. Turning legal obligations into automated processes. For example, instead of waiting for the buyer to mail you a check or wire the funds, smart contracts have direct access to accounts in order to immediately transfer the agreed upon amount. Access to accounts is controlled by a private “key” (which you can learn more about here) so as to make theft or other fraudulent activity much, much more difficult.
  2. Guaranteeing a greater degree of security. The blockchain creates a series of copies that are backed up many times over by independent actors and thus guarantee access to funds even in the event of loss, failure, or destruction of the copy on your personal computer.
  3. Decreasing reliance on trust. Historically, individuals have been hesitant to contract with unknown others for fear of fraud or other potential breaches of contract. A smart contract only deals in proof that events occurred or did not occur and executes the terms automatically when those events are proven. That comes with another set of problems, since the verification of whether an event occurs or not can itself be manipulated. Fortunately there are solutions being developed in the form of so-called oracles, e.g. Oraclize and Gnosis (learn more about oracles here, here, and here).
  4. Lowering transaction costs. There are lots of little savings along the way (avoiding the notary, time wasted communicating about payment, etc.), but the most significant difference is avoiding the legal system for a much greater subset of disputes. Since the contract is self-executing, there is no longer a need to sue the breaching party to show how they broke the contract (although that in itself doesn’t prevent you from suing). This avoids the cost of hiring a lawyer (huge financial cost), waiting for the lawyer to build a case and take it to court (huge time cost), and the uncertainty of whether the judge or jury will rule in your favor (HUGE peace of mind). The fact that so many suits (95% in the U.S.) never even make it to trial gives an indication about the high cost of trial. Additionally, the technology associated with the smart contract provides a platform to “test” different scenarios before reaching a final agreement. This will allow each party to KNOW rather than merely suspect what happens with the contract given different circumstances. This testing system also solves one of the biggest issues in contract writing which is anticipating consequences of unknown events.

5. Decreasing reliance on government. Many people see this as a good in itself (I’m looking at you, libertarians!). For the rest of the population however, government entities that otherwise would spend time and money acting in the legal system (as they currently do), can start to shift their focus to things that are more productive or better serve their citizens.

6. Easing burdens associated with collateralized property. As the “Internet of Things” grows and more devices connect to the internet and become “smart,” individuals can use that property as collateral for loans (just as they would now). However, the smart contracts connected to “smart” devices will be able to deny access to someone who defaults on payments as the devices themselves would be tokenized and attached to the blockchain directly.

7. Enabling real property transactions. Escrow is the most obvious example of how smart contracts increase efficiency. The process is exactly the same as now except it takes place and registers the transaction on the blockchain rather than filed paperwork at the government office. Additionally, proof of ownership and having “clear title” (ownership absent any liens, easements, or other encumbrances) is 100% traceable and reliable following the “digital representation” of the property.

8. Facilitating financial services. The transaction costs associated with buying and selling of financials instruments (stocks, bonds, etc.) can be greatly reduced using smart contracts, making it significantly cheaper and easier to make investments.

9. Reinvigorating copyright protection. Right now, digital copies of material (e.g. music, movies) are free to make and preventing it is nearly impossible. However, there are several projects working on ways to guarantee an artist gets paid for their creation and retains much greater control over how access is granted and how the funds are split for each purchase (check out Ujo Music).

10. Making gambling provably fair. Online gambling, and other independently verifiable events, will become easy and simple with smart contracts as at least two parties put into escrow the agreed amount to be released to the winning party after the game or similar event.

Anonymity available soon

As you can see, this technology has far reaching implications and we are only beginning to understand how far exactly. The blockchain itself is merely 7 years old and it is now dawning on us what it really is and where it can go. That being said, there are many problems to solve. One such problem with smart contracts is they are all pseudo-public and thus available to be read by anybody. The developers at Ethereum, the most successful network except for Bitcoin, are aware of these concerns and have made it a priority issue to solve alongside scalability. I think the technology will catch up and find a way to meet this need, but it’s not there yet.

Most contracts will not change at all (for example buying groceries at the supermarket), but as cryptographic technology becomes more widely accepted and used, the potential for smart contracts will become more and more obvious for those wishing to exchange goods and services. Just as credit cards, direct deposit, and electronic signatures have become more normal, smart contracts are the next step in technological advancement to simplify trade.

What we haven’t discussed yet is governance itself. With contracts moving from the world of people and things to the world of computers and bits, the way we govern society is subject to change as much as trade is. After all, if the demand for dispute resolution can be satisfied in ways other than the State’s legal system, the State itself will need to find new ways to justify its tax collection — or risk a legitimacy crisis. The United States Constitution was designed to allow flexibility to change as demanded by its citizenry, to allow a revolution to occur without overthrowing the system or chopping off the head of the king. But this has proven ineffectual.

Currently, there are multiple projects being developed aiming to compete with governments for governance services like notarization, identification, and dispute resolution. Renowned Bitcoin expert Andreas Antonopoulos recently announced his new project DAMN, the Decentralized Arbitration and Mediation Network. The DAO, an organization solely governed by code, raised more than $160M dollars worth of Ether (Ethereum’s crypto-currency). Philip Saunders, the Ethereum Fellow at Exosphere’s Academy, is building a prototype of Pax, a civic network and peer-to-peer legal system on the Ethereum platform. He even invented a legal scripting language called Codex.

As you can see, smart contracts are an exciting case of innovation in technology changing the way we interact. From July 11th to September 2nd, Exosphere Academy participants in the Philosophy Stream will take a closer look at how these things work and what they mean for you as an individual. And in the Ethereum Stream, you will learn how to build them yourself, and will be able to incorporate your projects on this prototype and thus be part of an historic experiment in governance innovation.

Let me know what you think,
Hoss


If you are interested in joining the Philosophy or Ethereum Stream, apply now to the Exosphere Academy!