e-commerce
p
PART 2
PART 3
PART 4
PART 5
Blockchain Technology & Smart Contracts
Learning Outcomes
30 minutes
After completing this module, students will be able to:
Definition of Blockchain and Smart Contracts.
Uses of Blockchain.
Running a program on blockchain.
Similarities between a Contract and a Computer Program.
Self - executing Contracts.
How smart contracts effect legal practitioners.
In Part 5, the main objective is to get a very basic understanding of what a Smart Contract is. The
term “Smart Contract” is often used in the same sentence as “Blockchain”. We will therefore also
have a look at what a “Blockchain” is.
It is very important to take cognizance of the fact that Smart Contracts and Blockchains are from an
academic point of view still very immature concepts. It is hard to find a single definition that
everyone agrees with. The definitions still seem very slippery, with large corporations using and
abusing the terms to fit their marketing messages. Things are still in flux and the meaning and
definition of these terms may still change. Keep this in mind and try to track the process by adjusting
and updating what is shared here, as you learn more about the field. What is said here may not be
completely in agreement with how the consensus on the meaning of these terms will converge in
the near future, but it still forms a valuable starting point.
Smart Contract
Blockchain
A simple definition comes from IBM (not an acknowledged source of academic information, but still
useful to aid understanding): https://www.ibm.com/sa-en/topics/smart-contracts
“Smart contracts are simply programs stored on a blockchain that run when predetermined
conditions are met.”
Euromoney provides a simple definition of a blockchain:
(https://www.euromoney.com/learning/blockchain-explained/what-is-blockchain):
“A blockchain is essentially a digital ledger of transactions that is duplicated and distributed across
the entire network of computer systems…”
If this makes perfect sense to you, you can skip the rest of this discussion. But if you find these
definitions a little hard to digest, please read on. The rest of this discussion will help you build an
understanding of these concepts, starting from very simple and known building blocks:
Important definitions:
Ledger
Digital Ledger
When people interact, they cannot always rely on memory alone, in order to remember what was
said and agreed to.
People easily forget and often do not agree on what was said. This causes conflict and parties may
easily end up in court.
It is better to record important information, than to try to remember details.
A ledger is a record of important information that people need to agree on.
The term “ledger” is most commonly used in accounting to refer to a record of financial transactions.
Financial transactions are typical important information with detail that should be recorded in a
reliable and trusted way.
A ledger can be in the form of a paper document.
It is important to record information in a ledger in a way which cannot be altered. Using a pencil to
record information in a ledger is a bad idea because it can easily be changed. This will erode trust in
the correctness of the information in the ledger. Using a pen which cannot easily be erased, is a
much better idea.
A ledger does not have to be on paper. It can be in digital format and stored on a computer.
Information in a digital format can be written and read much faster and in much larger quantities
than on paper. It is much more efficient to implement a ledger digitally than to record the
information on paper.
BUT digital information can very easily be copied, and records can easily be deleted or changed,
often without any trace that it has happened. This defies the whole purpose of recording
information in a ledger in the first place. To be a trusted source of information, the ledger should be
immutable (impossible to change).
A digital ledger can be controlled by a trusted third party. A bank is a good example of such a trusted
third party. The bank keeps the ledger and all its clients trust that the bank will not change or delete
any of the transactions recorded in the ledger.
The third party controls the ledger and can make changes for its own benefit. What if two parties
want to transact with each other and cannot find a third party that they both trust? Is it possible to
have a ledger where the two parties do not HAVE to trust a third party?
This is where a blockchain comes into the picture. This kind of ledger will make it possible for people
to transact with each other without having to trust a third party.
Blockchain
A blockchain is in simple terms an immutable (cannot be changed) distributed (spread over multiple
computers) digital ledger which does not rely on a trusted third party.
This is achieved:
By storing copies of the ledger not only on a single computer but on a very large number (typically
thousands) of independent computers.
By grouping new information into blocks before adding the blocks to the ledger.
By making every new block that is added, also depend on the information in the previous block that
was added (chaining the blocks together).
This chaining process relies on complex cryptographic computations which use a huge amount of
computing power, making it very difficult and time-consuming to repeat.
The result is an immutable digital ledger that can be trusted, because it is for all practical purposes
impossible to change fraudulently:
Because all the blocks in the ledger are chained (each block depends on the previous block).
Changing information in a block fraudulently, requires changing all the blocks that were added
AFTER this block. Since more blocks are constantly added to the blockchain and it takes a lot of
computing to chain the blocks, this becomes virtually impossible.
Because this process must be performed on multiple computers controlled by a very large number
of independent parties, on which the distributed ledger is stored.
Because the ledger is stored on so many independent computers, the trust in the ledger does not
rely on trusting any single entity. Parties doing business can confidently use the information in a
blockchain ledger without having to trust anyone else.
Uses of a Blockchain
An immutable ledger is a very powerful concept. Here are a few examples of where blockchain
technology can and has been used:
Cryptocurrency
Cryptocurrency is the result of trying to create a digital version of paper cash which (among others):
Can be accepted on face value (one does not have to contact a trusted third party to confirm that it
has value).
Cannot be spent twice (one cannot keep a copy after paying someone and use it again to pay
someone else).
Can be divided (to give change).
A blockchain makes it possible to implement some of the core features of digital cash.
Bitcoin is probably the best-known cryptocurrency using a blockchain. Bitcoin transactions, such as
paying someone for a product or service, are recorded in a blockchain where no-one can change the
records of the transactions. This makes it possible for parties to pay each other without having to
trust a third party such as a bank. Ether (EHT-implemented on the Ethereum blockchain) is another
example a cryptocurrency which is second only to Bitcoin in market capitalization.
Storing Public Records
Public records such as those held by the Deeds office (property registrations and antenuptial
contracts) must be recorded and stored in a way that can be trusted by the general public. Storing
this information on a blockchain means not even corrupt officials would be able to tamper with
records.
Recording Patent Registrations
Recording patent claims and priority dates in an immutable, tamper-free ledger such as a blockchain
have obvious advantages in insuring trust. (Have a look at:
https://www.wipo.int/wipo_magazine/en/2018/01/article_0005.html)
Running a Program on a Blockchain
The developers of blockchains are typical engineers and computer scientists. They do not like
repeating transactions manually. They probably very quickly made their own lives easier by
implementing mechanisms to automatically execute transactions. Very quickly the value of more
powerful computer languages, running on a blockchain was realized.
Solidity is the name of one such a programming language designed to run on various blockchain
platforms, in particular on the Ethereum blockchain.
The benefit of running a computer program on a blockchain is that not only can the result of a
transaction be stored, but the sequence of actions to arrive at the result, can also be stored in an
immutable way.
Smart Contracts
One of the objectives when drawing up a contract is to record an agreement as clearly and concisely
as possible. There should be no ambiguity as to what the intent of the signatories was. Contracts are
often structured to include: (https://lawexplores.com/contracts-structure-and-interpretation/):
The names and addresses of the parties
Recitals (non-operative (no special legal effect) background explanation)
Definitions
Conditions Precedent
Agreements
Representations and Warranties
Boilerplate Clauses
Schedules
Signatures
Appendices
A computer program has a similar goal: to record the intentions of the programmer in a way which
will always produce the same result when executed by a computer under the same conditions. For
this purpose, a language with a very structured format is used to specify computer programs.
There are similarities between a legal contract and a computer program. In fact, the programming
community has learnt and applied principles which legal practitioners use to structure a contract.
Without trying be exhaustive, it is interesting to note that it is good practice to start a computer
program with a block of comments explaining the background to what the program does. Similar to
the recitals section in a contract, which does not have special legal effect, these comments are not
executed by the computer.
Another similarity can be found in the definitions at the start of a computer program and the
definitions section of a legal agreement. Variables are defined at the start of a computer program
and used later in the program as shorthand to refer to a value with very specific meaning in this
program.
By way of an example, let us consider a simple contract that is signed by a taxi driver and his
passenger:
Contract between Taxi Driver and Passenger
The Parties to this Agreement:
Passenger:
Mr Smith
Driver:
Mr Johnson
Definitions:
Pickup Point:
Mr Smith’s home address
Dropoff Point: The Loftus Rugby Stadium
FEE:
R 250
Penalty:
R 50
Agreement
The Passenger requires to be transported from the Pickup-Point to the Dropoff-Point and the Driver
agrees to offer this service in exchange for the Fee.
This agreement commences when the Passenger contacts the Driver and the Driver accepts the call.
If the Passenger should not be at the Pickup point when the Driver arrives, the Passenger will pay
the Driver the Penalty.
If the Driver arrives with the Passenger at the Drop-Off-Point, the Passenger will pay the Driver the
full FEE.
Signed by:
Driver: ___________
__________
Passenger:
Date: ___________
__________
Date:
Place: ___________
__________
Place:
However, the driver and passenger do not know each other and have no reason to trust each other.
The passenger may jump out at the dropoff-point and run away without paying. The taxi driver may
take a longer route and demand a higher fee than agreed, upon arrival at the dropoff-point. And
although both parties may have signed the agreement, it may be very difficult for the driver to
collect the penalty, should the passenger not be at the pickup-point.
Self-executing Contracts
If, instead of relying on the parties to comply with the terms of the contract, the contract could be
programmed and executed by a computer system, the terms could be enforced without having to
rely on the cooperation of the parties. The following is an example of what such a computer
program implementing the Taxi Contract might look like when written in pseudo-code (computer
instructions which look very similar to a real computer program). It is not important for you to
understand the program below. The purpose is simply to give you an intuitive feel for the similarities
between legal contracts and computer programs. Simply read the code at least once to get the gist
of it. Please note that the following pseudo-code program does not include all the logic to
implement the contract. It is an over-simplified subset, just to illustrate the similarities between a
legal contract and a computer program.
PROGRAM: Taxi Contract App;
/* This program automatically pays the taxi driver when he arrives with the passenger at */
/* the dropoff point.
*/
/* The passenger pays a penalty if he is not at the pickup point when the driver arrives */
VARIABLES: PickupPoint;
DropoffPoint;
PassengerLocation;
DriverLocation;
PassengerWallet;
DriverWallet;
Payment;
EndOfTrip = false;
CONSTANTS:
Fee
Penalty
= 250;
= 50;
BEGIN
PickupPoint = PassengerHomeGPSCoordinates;
DropoffPoint = LoftusStadiumGPSCoordinates;
REPEAT{
PassengerLocation = PassengerCellphoneGPS();/* read passenger cell phone GPS */
DriverLocation = DriverCellphoneGPS(); /* read driver cell phone GPS */
IF (DriverLocation = PickupPoint) AND (PassengerLocation ≠ PickupPoint)
THEN {Payment
= Penalty;
PassengerWallet = PassengerWaller – Payment;
DriverWallet = DriverWallet + Payment;
EndOfTrip
= true;
}
ELSE
IF (DriverLocation = DropOffPoint) AND (PassengerLocation = DropOff_Point)
THEN {Payment
= Fee;
PassengerWallet = PassengerWallet – Payment;
DriverWallet = DriverWallet + Payment;
EndOfTrip
= true;
}
}
UNTIL EndOfTrip = true;
END.
Uber Example:
The Uber taxi service is an example of a contract which partially self-executes.
The Uber “Terms and Conditions” include the following clause:
(https://www.uber.com/legal/en/document/?name=general-terms-of-use&country=southafrica&lang=en)
Clause 4. Payment
You understand that use of the Services may result in charges to you for the services or goods you
receive from a Third-Party Provider (“Charges”). After you have received services or goods obtained
through your use of the Service, Uber will facilitate your payment of the applicable Charges…
You may elect to cancel your request for services or goods from a Third Party Provider at any time
prior to such Third-Party Provider’s arrival, in which case you may be charged a cancellation fee.”
These parts of the Uber contract have been coded into a software program. Instead of the passenger
and driver entering into an agreement by signing a contract with pen on paper, the two parties enter
into the agreement by performing actions on their mobile phones: The passenger uses the Uber app
on his mobile phone to hail a driver and the driver uses the Uber app on his mobile phone to accept.
The two parties agree that the passenger will pay the driver a certain amount when they reach the
drop-off point. The agreement executes automatically. The software monitors the GPS position of
the passenger mobile phone and does a credit card transaction as soon as the passenger arrives at
the drop-off point. There is no risk that the driver will demand a higher payment than what was
agreed. There is no risk that the passenger will try to get away without paying. The conditions that
were agreed to, are self-executing. It happens automatically.
Smart Contracts
A self-executing contract can only work if the parties trust that the contract will indeed execute and
implement what had been agreed to.
In the case of Uber, the driver and passenger probably do not know each other and probably have
no reason to trust each other. But since Uber controls the execution of the contract, it is not
necessary that the driver and passenger trust each other, as long as both trust Uber.
Putting a lot of trust in single organizations such as a mega tech-company or a government, poses
challenges of its own. These trusted third parties my abuse the trust put in them and interfere with
the execution of the contracts for their own purposes. Uber, for example knows exactly which places
their clients visit and has been accused of snooping on the movement of celebrities and persons in
public positions such as members of parliament.
The ultimate self-executing contract would allow for two parties to enter into a self-executing
agreement without the need to trust a third party.
We have already seen that a blockchain forms an immutable record of transactions and that
programs can be both stored and executed on the blockchain.
When a contract is stored and automatically executed on a blockchain, it forms a Smart Contract.
Two parties can agree to and record the details of a contract on a blockchain, without having to trust
a third party. And after the contract has been recorded, they do not even have to trust each other
anymore, knowing that when the conditions of the contract have been met, the result will be
executed automatically.
Example:
Trust Fund for Children: A parent can set up a trust fund for children and use a smart contract to
ensure that an inheritance amount will be paid out automatically to each child on his/her 18th
birthday, or even that a monthly allowance will automatically be paid out to the child until the fund
has been depleted.
An Oracle
Smart contracts often rely on external (to the blockchain) information to determine the conditions
under which to execute. Obviously, it is of little use to have a smart contract which is executed on a
blockchain and can therefore not be tampered with, BUT which relies on information which CAN be
tampered with.
An “Oracle” is a source of external information which can be trusted to form a reliable input to a
smart contract. One way in which to create an oracle, is to obtain the information from a large
number of independent sources.
For example, if a smart contract uses a currency exchange rate to decide when to make a payment, a
way to implement an oracle (reliable source of the exchange rate data, that cannot be tampered
with), the average exchange rate can be calculated from a large number of independent companies
and government departments reporting the exchange rate. This way it will be very difficult for
someone to interfere with the execution of the smart contract.
Examples of Smart Contracts
Trading and Investing:
Investors can draw up a smart contract that will automatically buy or sell stocks, based on the stock
price, without using an intermediary (trusted third party) and without the buyer and seller even
having to trust each other. The smart contract includes the payment transaction.
Air Travel Refunds:
A smart contract can monitor the real take-off times of airplanes and automatically execute the
small print on the air ticket that states that the traveler will be refunded, should the airplane not
take off within a certain time period of the scheduled takeoff time.
How do Smart Contracts affect Legal Practitioners?
Whenever computers take over work that has traditionally been done by a human, there are
doomsayers predicting that people will soon be out of a job. In the case of smart contracts, there are
those who believe it would soon put contract lawyers out of work.
The reality is that technological advances often open up more work and more opportunities. It is
doubtful that smart contracts will replace attorneys. The legal aspects of a contract still stay within
the legal domain to be taken care of by legal practitioners. Technology cannot replace this.
For example, an illegal contract is not legally binding, regardless whether it is “smart” and executed
by a computer. And often the intent of the parties to the contract plays a major role in the validity of
a contract. Smart contracts may be very abstract and hard to grasp for those without a technical
background. The services of a legal practitioner will still be required.
Smart contracts are here to stay and will most likely stimulate a closer connection between software
engineers and the judicial system.
Those legal practitioners who manage to embrace the new technology will probably find their
services to be in high demand. Smart contracts are probably much more of an opportunity than a
threat to the legal profession.