Put the “Smart” in Smart Contracts, or the Law May Have To

In today’s modern sharing economy, the next frontier is the instant sharing of information. Blockchain technologies utilize a shared ledger database, that automatically updates. Each user has an identical copy that is stored and controlled by individual users. Blockchain benefits users by removing middlemen, such as banks, and automating transactions. Blockchain is typically used to manage the virtual transfer and management of money, such as BitCoin, but the benefits of this system have begun to extend.

Since Blockchain ledgers are hosted by all users, users can interact with each other anonymously with a high degree of confidence regarding the reliability of the ledgers of others. Smart Contracts use these Blockchain ledgers in conjunction with automated if/then statements to facilitate transactions. These if/then statements automatically react to pre-determined inputs, such as a timer running out or a package being scanned. For example, an art auction could use Smart Contracts to facilitate an anonymous auction using the following if/then statements.

  1. If a bid exceeds the current highest bid, then that bid may be placed.
  2. If the bidder does not have sufficient funds in their ledger, then a bid cannot be placed.
  3. If the bid is placed outside of the auction period, then that bid will not be accepted.
  4. If the auction period is closed, then the art piece shall be shipped to the buyer.
  5. If the piece of art is scanned to have arrived at the buyer’s address, then funds shall be transferred from the buyer’s ledger to seller’s ledger.

While some of these if/then statements, such as the placement of a bid, require user input, the beauty of Smart Contracts is that most of these statements can be automated. However, just like normal computer code, the order of the Smart Contract’s clauses will affect execution of the contract. For example, in the contract above, although the Smart Contract checked the ledger at the time of the bid to ensure the buyer had sufficient funds, there was no check before shipment of the art. This could put the seller in a tenuous position – as they have now shipped a piece of art to an anonymous buyer with no guarantee that the funds will ever be transferred. While there are certainly easy solutions for this particular problem available for Smart Contracts, such as putting payments in escrow, the law is unsettled when it comes to Smart Contracts and their enforceability if there are bugs. A buggy Smart Contract could have dire consequences – such as pulling the wrong amount from the buyer’s ledger or pulling from the wrong bidder’s ledger.

To understand the intent of the contracting parties, traditional contracts are taken as a whole. However, since Smart Contracts are written in computer code, and executed automatically in a series of blocks, the intent of the contracting parties may be obfuscated, and make resolving issues that much more complicated. If your business is interested in using Smart Contracts, contract smart. Test out your Smart Contract before executing it in real time. Ensure that each if/when statement is placed so it has the desired effect. Finally, ensure that additional precautions are in place to minimize the risks of contracting with anonymous users.  If you don’t, you may find yourself in a court of law, applying legal principles to situations never before litigated.

Article contributed, in part, by University of Texas law student Hayley Ostrin.  Published by Hall Law attorney Brian A. Hall.


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