Blockchain and smart contracts

Arthur Piper

Transactions are likely to be fundamentally different in future. The role of lawyers, brokers and bankers could also be transformed.

Blockchain technology could become as important to the world as the building blocks of code underpinning the internet, according to two Harvard Business School professors. Blockchain – the architecture underlying bitcoin and other virtual currencies (see box: Blockchain explainer) – is popularly seen as a disruptive technology by many. But, Marco Iansiti and Karim Lakhani disagree with this classification, arguing instead that blockchain will become the foundation for the way that all digital contracts, transactions and records will be executed and stored in future.

The effects will be revolutionary. Smart contracts, for example, built on automated blockchain payments, could rewrite the relationship between buyers and sellers, employers and employees in ways that could undermine traditional professions.

‘With blockchain, we can imagine a world in which contracts are embedded in digital code and stored in transparent share databases, where they are protected from deletion, tampering and revision,’ Iansiti and Lakhani say in their recent Harvard Business Review article ‘The Truth about Blockchain’. They suggest that ‘intermediaries like lawyers, brokers and bankers might no longer be necessary’.

Even if lawyers manage to survive, they may have to become blockchain software experts and programmers. In addition, ‘they’ll probably have to rethink their hourly payment model and entertain the idea of charging transaction hosting fees for contracts,’ the authors say.

Today’s status quo is unlikely to change significantly for another 30 years if their predictions are correct. ‘Unlike the development of the internet, the infrastructure is already in place for blockchain to take off,’ says Joost Linnemann, Attorney-at-law at Kennedy Van der Laan in the Netherlands and IBA Technology Law Committee Membership Officer. In the back offices of banks, for example, blockchain applications are developing quickly. While there’s not likely to be a big bang, he says, at some stage the blockchain era will have arrived.

Blockchain explainer

A blockchain is a distributed database. It comprises a list of ordered records called blocks. Each block is linked to a previous block and is time stamped.

Once users on the system enter into a transaction, it is recorded with its unique time stamp and is permanent. Individual blocks cannot be deleted and are visible to anyone with access to the system.

The data that has been saved to a blockchain is currently cryptographically safe. Any attempt to modify a block’s content invalidates the unique references that place it in its position in the chain.

Blockchain currency (eg, bitcoin) recipients share their public key with the currency sender. To spend a unit, the owner must use their own private key. If another party learns the private key, that party can spend the currency. The transaction is irreversible.

Smart contracts are codes that enable the self-execution and validation of data and transactions. When defined conditions are met, the code is triggered. Music streaming services, for example, could use this to automatically distribute artists’ performing rights on their networks without having to use central collecting agencies.

Linnemann is also sceptical about the disappearance of lawyers with the proliferation of smart contracts. After all, automated contracts are not new – that is what a customer’s standing order to pay a monthly mortgage is, for example. The difference with a smart contract is that, once the agreement is in place, the bank cannot decide not to perform it. 

But, the profession is going to have to change. ‘There are not enough people in the legal profession who know what blockchain means,’ Linnemann says. Lawyers are going to have to learn how smart contracts work in practice and what the trigger points are for payments and other transactions – knowledge of which today is usually provided by the client.

‘You will need the right kind of education for both lawyers and developers so they can work together effectively,’ Linnemann says. He sees the integration of legal advice and computer skills as a huge opportunity for those firms willing to act.

Information Technology, legal and compliance risks for blockchain ecosystems still have a long path ahead to reach maturity. ‘The tech industry may be fast-moving, but the insurance business may need to go at its own pace,’ says Sebastian Rath, Principal Insurance Risk Officer at NN Group. The same will be true for law firms. Risks that are not adequately anticipated and mitigated could lead to financial and reputational losses.

Intermediaries like lawyers, brokers and bankers might no longer be necessary

Marco Iansiti and Karim Lakhan
Professors of Business Administration at Harvard Business School, Boston

Rath emphasises that businesses should ensure they have a solid understanding of blockchain, its intended use across the organisation, and have buy-in from the top. ‘Reaching a sound commitment to fund these projects can be a long journey, depending on a firm’s opportunistic agility to exploit new technologies,’ he says.

Rushing may not be an effective approach, as blockchain is currently being tested in almost every sector, from transparent healthcare, to agile supply chains, to faster and economic settlements in risk transfers, to the deployment of virtual currencies. All of these areas will face continued developments of technical standards, industry guidance and legal frameworks. ‘That’s why combining a clear vision, talent pool and awareness of key risks should be the most sensible start to protect the return on funded projects,’ Rath says.

Despite blockchain’s reputation for high-level security, virtual currency providers using the platform have been hacked. Tokyo-based bitcoin exchange Mt. Gox, for example, was forced into bankruptcy after a $460m security breach in 2014.

As blockchain currencies and smart contracts grow in popularity, hacks will increase. So far, such attacks do not seem to have breached the core technology, but have exploited security lapses around the way it is implemented, or have relied on traditional deception. Firms developing smart contract technologies could be vulnerable if they don’t have the right safeguards in place around their blockchain processes.

A growing concern, though, is that blockchain may be built on a digital house of cards. Late last year, a study by the Global Risk Institute found there was a one in seven chance that the key cryptography tools that thwart hacks will be broken by 2026, with a 50 per cent chance that that would happen by 2031. The result could be an internet with no data encryption and blockchain codes that can be cracked in a couple of minutes.

Pen and paper, anyone?

Arthur Piper is a freelance journalist. He can be contacted at arthurpiper@mac.com