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Where are we going? Exploring the Blockchain’s Utility.

Oct. 2, 2015, 8:02 PM

Editor’s Note: The authors of this post are attorneys at Holland & Knight and are writing a series of articles on blockchain technology and its potential application to the legal industry. Below, the fourth article sets out practical uses of the blockchain and its potential applications in the future.

By Joe Dewey, Partner, and Shawn Amuial, Associate, Holland & Knight

In our last article we went through great lengths to highlight the glaring impact that the blockchain could have on an entire industry — the real estate industry. We’ve also cited the impact on other industries such as FinTech, estate planning and countless other areas. All of this is exciting, but we haven’t discussed some more practical considerations. Yes, blockchain technology, and smart contracts specifically, have been called ‘game changers’ for the legal industry, but where does things stand today? And what is it going to take to move from the theoretical stage to the practical stage where lawyers will be writing smart contracts and using the blockchain to implement them?

In order to understand where we are today, one must start with Ethereum.

Ethereum is an open source blockchain protocol similar to Bitcoin, but more ambitious in capability. Let’s explain. Bitcoin is an amazing technology, but its focus is cryptocurrency — the simple transfer of digital money (as discussed in our first article ).

Ethereum, on the other hand, utilizes similar technology, but is more robust is being built to specifically support smart contracts. The premise is that contracts can live on the blockchain constantly listening to see if a counter-party has performed, and depending on the answer to that question, communicate appropriate instructions through the blockchain protocol. Taking things a step even further, Ethereum can be used to form decentralized organizations whose ownership and corporate governance are dependent on code uploaded to the Ethereum blockchain — entire corporations operating autonomously in a digital/virtual world — imagine an business autonomously running on the blockchain, self-governing its actions in accordance with the bylaws in which it was coded. Readers can learn much more about Ethereum’s mission and the current status of their development at ethereum.org .

While some smart contract start-ups are built on top of the Bitcoin protocol, several start-ups have built smart contract platforms on top of Ethereum’s blockchain protocol. These start-ups are marketing their applications to law firms, financial institutions and other consumers. But these applications are still tailored to a discreet library of contracts (e.g., basic escrow arrangements), with anything else requiring custom coding that is tailored to the specific contract desired by the contracting parties (for examples of existing smart contract providers, check out etherparty.io and smartcontract.com). While such applications can provide value even today, the future of sophisticated and tailored contracting will require that lawyers remain in the driver’s seat in terms of managing the construction of contracts. We don’t say this out of a desire to save our jobs (although one day we may become obsolete), but because contracting parties rely on legal counsel to appreciate risks associated with potential relationships and to understand the implications of those relationships under the laws and regulations by which we are governed. In other words, people need lawyers to know whether their proposed conduct will result in loss and/or incarceration. This counsel can’t be replaced by a computer programmer (at least not yet).

What all this means is that we are still some time away from lawyers being able to draft anything that resembles a traditional contract, and then with a press of a button, have the ability to convert that traditional looking contract into a smart contract in a form ready for life on the blockchain. Rather, a programmer is still a necessary intermediary. Lawyers draft in English, French, Spanish and other official languages. Coders draft applications in C++, JavaScript, Python and so on. What the legal industry needs is a bridge — one that connects the coders and their amazing technology to lawyers and their ability to understand how contracts serve to govern relationships between people and society in general.

Some have suggested that lawyers learn to draft in HTML-like format (similar to the language web browsers read). In theory, there is a lot of merit to this suggestion, which would give contracts additional functionality because of embedded tags in the contracts. But in reality, it’s unlikely to be implemented. Instead, developers will need to develop applications that can digest traditional contracts and convert them into digital records ready for the blockchain. The most logical approach would seem to be a language that could convert written contract clauses, or in some cases, entire documents into programming objects. Those programming objects could then be converted into whatever machine code is required by the applicable blockchain.

In addition to the inherent benefits of smart contracts, there are other benefits that would arise out of a system of contracting with a programming layer on top of traditional contract drafting.

Maybe the most obvious benefit of code-based contracts is the transactional efficiency of being able to automatically generate contracts based on agreed-upon patterns and syntax — something unlikely to develop in our current contract drafting and negotiating environment. Maybe even more beneficial than the efficiencies gained by automation is the fact that code based contracts would be capable of debugging themselves.

In other words, a code-based contract platform would spot errors and inconsistencies within a contract through machine logic. For example, if a contract contains an object of logic which provides that the contract is between two parties, but the contract’s execution contemplates the signature of more than two parties, an exception would be thrown by the program and the coder alerted to the inconsistency. That’s an obvious example that even the least capable drafter would certainly spot.

More difficult issues, however, would also be capable of prevention. The platform could spot more nuanced inconsistencies — such as an object requiring one party to provide insurance, while another object provides for something inconsistent with such logic.

As discussed below, advances in artificial intelligence will soon allow machines to understand more and more complex logic, and ultimately, be capable of alerting a drafter to inconsistencies that often go unnoticed by human drafters. In addition, the speed at which these errors could be spotted by a computer are exponentially faster than that of a human lawyer. What would take three hours of human time could be done by a computer in one second.

Another benefit would be the ability to code into the platform regulatory and other compliance logic. For example, if a drafter is generating a promissory note where the governing law is a state’s whose maximum permitted rate of interest is 25 percent, then if the drafter attempts to add an interest object with an interest rate of 26 percent an error would be thrown.

The ability to have a machine apply this sort of compliance logic would save certain industries an almost immeasurable amount of time and money, including the financial and securities sectors. This is a rather simple feature to incorporate into smart contract building, but far more powerful features will become available as advancements are made in machine learning. For example, an algorithm that can search existing databases of contracts (such as EDGAR ) and determine when there are changes in “market” provisions found in certain types of contracts. The machine can then implement those changes in a company’s own form contracts.

The machine learning code would need to be able to distinguish between different types of contracts (e.g., this is a credit agreement) and learn from human corrections that override its automated changes. For example, if the machine believes that a certain type of provision is being added to credit agreements and recommends adding the same provision to the company’s form, then the machine would learn from the human operator when it tells the machine that it is not appropriate to add in this case because that clause was in response to a law not in effect in the jurisdiction within which the company does business. Ultimately, the machine could even learn how the various provisions in a contract work together, so that if a change is made to one provision, the machine could alert the drafter to changes that should be made to other provisions on the contract.

Finally, code based contracting will generate huge efficiencies in contract management. With contracts distilled to electronic logic, enterprises who may have hundreds, thousands or hundreds of thousands of executory contracts (think of Apple, Amazon, Exxonmobil) would be able to establish automated systems plugged into their database of electronic contracts. In other words, they would no longer need to have hundreds or thousands of individuals responsible for managing these contracts. In addition to massive cost savings, the quality of management would likely increase due to the lack of human error.

We’ve covered a fair amount of ground over the last four articles, and hopefully, our readers have a better understanding of the blockchain technology and its potential applications in the future. But all of this begs the question of what law firms should be doing in light of this innovation. We have saved that discussion for our next article — one that many in law firm management will want to read.