Blockchains and smart contracts

This year has seen BNP Paribas Securities Services team up with Axa Investment Managers on a blockchain project. Blockchain projects are popping up in Switzerland, USA and even the UAE. It is thought by many that blockchain will change the way business is conducted by changing the way finance, data and transactions are validated and tracked.

What is blockchain?

A blockchain (or also known as distributed ledger) is a database. It is a database of any information that is recorded, i.e. the transfer of bitcoins and the tracking of transfers of physical assets such as diamonds. Blockchains store data into blocks, whilst chaining “them together to form a cohesive, unbroken record of that information.” This database can be described as a register in a sense, made of “digitally recorded and encrypted … data in the form of blocks, which when connected via the distributed network of computers storing the blocks, form the blockchain.”

Blockchains consist of a peer-to-peer network. Each node (each computer in the network) on this network can have a copy of the whole ledger. As the data is distributed across a network of computers, ledgers operate by consensus and a single ledger cannot be in sole control. This is one of the reasons blockchain has gained attention, as this is very different from a bank and blockchains make real-time data records of transactions meaning the data cannot be changed, deleted and they are highly hack resistant.

However, blockchain has many uses, some exist and some do not as of yet. The possibilities of blockchain technology include bonded transactions, multiparty signatures, third party arbitration, recording property ownership, verifying the origins and authenticity of diamonds, secure voting in elections etc.

What is a smart contract?

Here, a contract can be enforced through a computer code that executes the terms and conditions of a contract between parties. The more complex the code is, the ‘smarter’ the contract is as this enables the contract to execute itself without anything to compel a party to act to enforce the contract. This results in autonomous parties such as Internet of Things devices entering into smart contracts without the need for human interference, creating computerised agents. As smart contracts run on a blockchain, they run exactly as programmed without any possibility of fraud or third party interference. However, this also shows just how inflexible a smart contract can be, requiring a change in the code to change a provision in the contract. This may change as time goes on due to technology constantly developing.

Coders are able to formulate the smart contracts in the framework that they want, imposing limits on the contract. This could lead to parties paying coders to get tailor the smart contracts to their particular needs, resulting in a market which is driven by customers. Coders could be assisted by lawyers in the future to draft contracts.

Security

The code behind the blockchain was released under an open source licence meaning that users can see if the coding has security flaws or contains backdoors, thus knowing that it should not be used. This creates transparency in the blockchain that is being used. The ledger is checked for consistency. Privacy is also not affected as pseudonyms are used. However, if a particular blockchain asks for a user’s identity, then this information will be viewable by all who use the particular application, meaning the ledger would not be compliant with EU data privacy rules. This creates a challenge in identifying who the data controller or the data processor would be.

Legal issues

Smart contracts are still subject to the law of contract as smart contacts can be traced back to a human. As there are many hypothetical scenarios to deal with, the answers cannot be fully determined and legislators can only start to provide working frameworks when blockchains are more widely used. However, there is a question as to which jurisdictional laws would apply to a blockchain when servers and ledgers could be scattered all over the world. Some argue whether smart contracts can be considered contracts at all as they are every different to contracts on paper. Questions on how to terminate a smart contract arise, as they are self-executing. Can an offer and acceptance be applied to a smart contract in a blockchain? These matters could be solved by incorporating certain terms and conditions into the smart contracts. The anonymity granted to those in the blockchain could give rise to questions surrounding money laundering. Then, there is also the issue of recourse.

Conclusion

If there is anything we have learned from the journey of bitcoin, it is that technology will continue to develop. Blockchain and smart contracts will also continue to revolutionise and transform. The blockchain and smart contract as we know now, may well be very different to the ones that will be used in everyday transactions in the future. We encourage everyone to keep up to date with evolving technologies that can have an effect on the legal world.