The popularity of Bitcoin which was introduced by a person under the name Satoshi Nakamoto back in 2008 has paved the way for the rise of blockchain technology. Although usually associated with cryptocurrencies, many technologists, financial firms and banking institutions believe that the application of blockchain is beyond currency.
The application of this technology in enforcing legal contracts to digital transactions has been making headlines recently. In fact, several consortiums are formed by some of the biggest institutions and organizations globally to intensify the research and development of platforms loosely based on blockchain running digital contracts, such as Etherium and R3 Corda.
What is Blockchain?
To understand better how blockchain can modify the current landscape of legal contracts, we must first delve into the key concepts behind this technology. Blockchain can be summed up by its properties: decentralized, transparent, and immutable.
Blockchain is a decentralized ledger, designed in such a way that stakeholders residing within a network can access and update the records without the permission of a third-party intermediary. This is in contrast with a centralized ledger, like what most of businesses are currently using, in which any record access or update must be validated and authorized by a single trusted party to proceed.
Blockchain maintains transparency by making sure that distributed copies are always identical. The system is configured to synchronize regularly so everyone in the network can view the exact set of records at any time.
In blockchain, transactions are immutable, meaning any modification of a previous transaction will fail. To store a valid transaction, the details of the previous transaction are hashed using complex mathematical algorithm and the resulting key is used to sign the new transaction. This process of encryption linearly links transactions together, thus modification of a record would require manipulation of the whole chain.
If you are just starting to learn about blockchain, I suggest you check out some books available discussing this topic like Blockchain for Dummies.
How Blockchain Can Transform Contract Enforcement?
In 1994, Nick Szabo introduced the concept of smart contracts in his paper The Idea of Smart Contracts. He discussed how a contractual clause can be translated into computer programs and be embedded into hardware or software systems to execute automatically the specified instructions. These are similar to stored procedures in databases which can execute without any human intervention to carry out the conditions specified in its logic to the target records.
Some blockchain-based platforms like Etherium enables developers to run smart contracts. With this capability, traditional contract implementation can significantly improve in the following perspective:
Reduce intermediaries between parties
Legal contracts usually requires a middleman to validate if transactions comply with the required conditions. When you go to a bank to apply for a loan, you are required to submit several documents to prove your eligibility. The documents you have provided should be approved first by a number of bank personnel before the loan can be granted. Before, acquiring the pertinent documents like account statements from other banks and tax records would require you to manually coordinate with the agencies managing these records.
In a blockchain system, banks and other agencies can coexist in a network and share the information for a particular client. Your tax payments and other bank transactions for example, can be easily accessed by the bank where you are applying for a loan. Verification of documents can also be executed via smart contracts.
Efficiency on imposing legal contracts on transactions
Automation is equal to efficiency. With smart contracts, the obligations and penalties that should be applied to a transaction can be done automatically and almost in real time. This speeds up the process since it somehow reduces human intervention.
Blockchain also streamlines the process of handling transactions since its design enables peer-to-peer data sharing.
Lower the cost of maintaining transactions
According to a study by Santander FinTech, banks can save up to $20 billion a year in terms of infrastructure costs with blockchain technology. They attribute the cost reduction to the elimination of central authorities that verifies transactions and expensive payment networks.
Transparent ownership rights
The immutable feature of blockchain prevents modification of ownership information of any transaction and this information is visible to all stakeholders within the network.
When to Jump Off the Cliff: Adopting Blockchain
Transitioning to a new technology is never easy, considering its instability during the early stages of development. In the book Innovations and Its Enemies by Calestous Juma, he discussed how farm tractors were initially dismissed because horses work more efficiently than these machines when it was first introduced in the US.
Same is true with blockchain. At this point, the community backing up the technology are facing some issues which make some people question the legitimacy of its promises. Recent hacking of blockchain networks which involve millions of dollars stolen from rightful owners are quite disturbing since security is one of the key reasons why blockchain is favored over the others.
These are a few considerations to help businesses decide on whether to join the blockchain bandwagon:
Yes, transactions on blockchains are impossible to alter without detection and cannot be successful without manipulating the whole chain in the network. Running a smart contract would make the difference however. Black hat hackers can exploit the loopholes of a legal contract to conduct illicit activities on transactions. This what happened last year when a theft diverted millions of dollars worth Ether from DAO (Decentralized Autonomous Organization) to his account.
Closely evaluate the security protocols implemented on the blockchain platform that you are planning to use in your business. Data breaches cannot be totally eliminated but can be mitigated by some security measures. You might also be interested to read this article on some rules to secure smart contracts.
Adopting blockchain demands overhauling your current infrastructure and processes as well as updating the skill set of your human resources to facilitate its requirements. Take into account the ROI of shifting into this new system. Also, analyze how it will impact your current and target clients in terms of cost and sustainability of the business model.
Since blockchain technology is relatively new, regulations and standards are not yet established. In case of disputes on digital transactions involving smart contracts, it is still unclear how the current laws would handle such. Maybe in the future our legal system would adjust accordingly, but for now uncertainty remains on the litigation process when legal issues arise.
Take the Plunge?
On paper, the blockchain technology, together with smart contracts, can revolutionize commercial contract management for different sectors. However, its success on taking over the market heavily relies on how the proponents of this technology can address the issues and how they can continuously improve its different aspects.
If you are contemplating on using blockchain in the future, I suggest you keep an eye on its development and assess how it can propel your business to greater heights.