February 2017 Bar Bulletin
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February 2017 Bar Bulletin

Smart Contracts Are Coming: Are We Ready?

By Vi Duong


Imagine this: A buyer buys, obtains title for, and takes possession of a used vehicle without ever meeting the seller or dealer or even leaving his home. He finds a car he would like to purchase and makes an offer for the car by sending the seller a contract — or rather, a smart contract. The seller accepts the smart contract, and at the moment of acceptance, the following actions occur automatically:

(1) Information regarding the car such as ownership, liens, VIN, mileage, maintenance history, and other pertinent information is instantly verified to ensure that the vehicle is exactly as advertised.

(2) Once all of the car’s information is properly verified, the buyer’s payment is withdrawn from his account and deposited into the seller’s account, while simultaneously, the vehicle’s title and registration are updated with the buyer’s name as the owner, and the car’s computer system replaces the seller’s credentials with the buyer’s credentials allowing only the buyer to unlock and operate the car.

(3) The vehicle then drives itself to the buyer’s driveway.

Although the scenario above1 may seem futuristic and perhaps even like science fiction, such an automatic transaction will soon be possible with a full-fledged Internet of Things (IoT)2 by using a smart contract on a mature and secure blockchain.3 The benefits of a smart contract, like that of any new technology — increasing efficiency and predictability while decreasing costs and time — will alter legal practice.

This article provides a basic introduction to IoT, blockchain and smart contracts, not in their current state, but as they could be with further development, and discusses the potential effects of smart contracts on legal practice.

Basic Introduction to IoT,
Blockchain and Smart Contracts

Smart contracts are not the types of contracts that form-filling/clause-
selection software generates. Such generated contracts, like any other traditional contract, are written in natural language. A smart contract, on the other hand, uses computer programming languages to express the agreement between parties.

Because a smart contract is simply a piece of computer code, it can be programmed to do more than just document each party’s agreements, which is the intended, and only, feature of a traditional written contract. For instance, a smart contract can be programmed to verify a party’s representations (such as verifying the ownership of the car) and enforce a party’s obligations (such as withdrawing funds and transferring title). Thus, a smart contract — “the use of computer code to articulate, verify, and enforce an agreement between parties”4 — may be used to substitute for or supplement a traditional contract.

The idea of a smart contract, developed two decades ago,5 remained a theory until recently. There were two major technical hurdles to overcome.6 First, a smart contract needs to have access to and control of each party’s assets and information about the assets in order to verify the assets and enforce the transaction. In the car purchase example above, the smart contract must be able to verify information about the car, transfer the payment from the buyer to the seller, and update the car title.

Second, a smart contract needs a computer that is secure and trusted by all parties involved to run its code and enforce the terms of the contract without the need for human involvement or the ability for human interference. Both of these hurdles are being overcome with IoT and blockchain technology.

The IoT addresses the first hurdle by bringing every object online, thereby making them accessible and controllable by a piece of computer code, such as a smart contract. New iterations of common objects — from door locks to household appliances — are embedded with sensors, electronics and software that allow these items to collect information and communicate with other items connected to the Internet.

In a full-fledged IoT world, a car’s tire pressure, maintenance history, accident history and all other information could be automatically collected by the car and stored online. Likewise, databases containing information regarding title and registration can be uploaded online. The place where these databases reside online could be a blockchain,7 as further discussed below.

Once databases of relevant information and assets are either stored online or connected to the Internet, a smart contract can be programmed to access the available information and assets to verify the conditions necessary to initiate a transfer of assets, and, once these are verified, automatically transfer assets and information between parties to an agreement.

The blockchain technology8 addresses the second hurdle by providing a trusted computer — or rather a network of computers that can be trusted collectively — to execute the smart contract. A blockchain is a cryptographically secure digital ledger9 of transactions that are shared in a pseudo-
anonymous, peer-to-peer computer network in a decentralized manner.

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