Amsterdam Law School
Commercial Business Law
Master Thesis
Hazhah Salah Turski, LL.M. Candidate, 2018
Submitted 26 September 2018
Advisor:
mw. mr. dr. C.G. (Cathalijne) van der Plas
&
mw. dr. A.E. (Marieke) Oderkerk
Acknowledgement
This master’s thesis is written by an LL.M student studying at the University of Amsterdam, faculty of Private Commercial Law.
The author wants to thank Dr. Andrzej Turski, Izabella Turska, Cathalijne van der Plas, and Konrad.
The author wants to thank Dr. Turski for his extraordinary explanation of blockchain
technology and for his valuable feedback and guidance. In particular, I want to thank him for his assistance in identifying the possibilities and the limitations for the adoption of the blockchain-powered smart contracts. Thanks to him, I was able to write a multidisciplinary thesis that helps legal minds to understand blockchain technology for legal purposes.
In addition, I want to thank Izabella Turska for hosting me for six weeks and facilitate us with a great workplace, the library. Besides that, I want to thank her for her interesting feedback on how to translate legal conditions into a logic flowchart.
Moreover, I personally thank mr. C. van der Plas. Her flexibility and her trust in me were what made this thesis possible.
Last, but not least, my warmest thanks goes to my husband, Konrad. I want to personally thank him for proofreading the Thesis. Thank you for your guidance, your feedback and moral support - We have built another block, based on proof-of work consensus and thanks
to our complicated mathematical hash-puzzle, our chains are unhackable and immutable.
Abstract
This work gives an introduction to the application and adoption of the blockchain technology for the legal sector. Understanding the technical characteristics, issues and limitations of blockchain-powered smart contracts is necessary for the legal sector to make responsible choices surrounding the adoption of smart contracts for legal purposes.
Blockchain is a technology that allows users to digitally broadcast information onto a shared ledger. This information is distributed to nodes (computers) using a decentralized, peer-to-peer network. Each node verifies the validity of the information and, using a consensus-based system, determines which information will be compiled into a “block” and added to the ledger. This ledger, which is called the blockchain, is stored across all nodes in the network and once the information is stored on the ledger, the information becomes
immutable. In addition, smart contracts are extensions to blockchain technology that allow to execute software-coded actions and record their results using the blockchain.
Much has been written on how the blockchain technology and, in particular, smart contracts may affect the legal sector. However, most of the knowledge is based on theory and
predictions of possible use cases, rather than empirical research. As a consequence, there is a lack of empirical research illustrating how a smart contract can be built according to legal standards. This paper seeks to address this gap in the literature by presenting a
multidisciplinary analysis addressing the following question:
To What Extent is it Possible to Build a Blockchain-Powered Smart Contract that Establishes and Executes an International Sale of Movable Goods Agreement and is in Compliance with Private International Laws?
To answer this question, I first provide an overview of blockchain technology and smart contracts, discussing in particular the limitations and issues affecting this emerging technology. I then provide a legal framework surveying the basic legal conditions for an agreement, and discuss in detail what laws would apply to a smart contract are that would be built to execute and establish a sale of goods agreement.
Following theoretical overviews of blockchain technology and the legal framework, I apply the technical and legal knowledge to present a prototype smart contract built for the purposes of this paper and based on the aforementioned legal conditions.
Through the process of developing this smart contract, we identified several main takeaways. (I) First, in order to build a legal smart contracts, lawyers need to able to embrace formal logic thinking and, in particular, a decision-tree or flowchart-based legal approach. This decision tree is needed to serve as a guidance for programmers throughout the building process.
(II) Second, we discovered that some type of legal work are more suited to be replaced by a smart contract. In particular smart contracts are well-suited to replace (1) legal work that establishes ‘trust’, (2) legal work involving an exchange of assets, (3) legal work that is repeatable, and (4) legal work involving technical mechanism for resolving disputes.
(III) Thirdly, we discovered that subjective, non-deterministic legal words are particularly problematic for programming a smart contract. It is all but impossible to encode vague and too-broad legal definitions into this type of technology.
(IV) Fourthly, questions related to the identity of the signing parties and their privacy are likely to be one of the biggest issues in this technology. Blockchain technology is, by design, based on anonymity, with users using so-called Public and Private Keys to sign their
transactions. However, the Public key is a random code based on cryptographic algorithms, and it is by definition difficult to determine any information about the user behind the Public key. In other words, identification of the parties in a contract is difficult. On the other hand, the transactions (or information broadcast to nodes using blockchain technology) are
transparent, stored on a decentralized shared ledger, and hence accessible to all participating parties. The moment someone figures out what entity is behind a particular Public key, their entire transaction history is accessible, in violations of the law (we called this in this work the double curse).
We recommend the intervention of a third party, external company, to solve the
under the supervision of the government that are authorized to issue public certified public keys stored on a USB Stick. In doing so, identification is guaranteed, and users meet the legal requirement of authenticity of signatures.
(V) Fifth, issues may occur when there is a bug or exploitation in the code.
As mentioned before, smart contracts are only capable of executing code that is already in their programming. Hence, a crucial legal question arises when the smart contract mistakenly or deliberately produce an outcome not intended by the contracting parties. To address this possibility, we recommend Legal Smart Contract builders to encode beforehand conflict resolutions mechanisms into their smart contracts.
(VI) Finally, three of the most notable limitations of the current blockchain technology, as measured by their relevance to legal viability, include (i) limited space, (ii) the impossibility of executing actions after a pre-determined time has passed, and (iii) exception handling.
This work is limited insofar as it only examines, in general terms, the legal qualification for the existence of an agreement in a smart contract. It supplements this inquiry by providing an introduction on how to encode applicable law and competent court clauses in a smart
contract.
There remains a need for additional empirical research across multiple legal sections on how to built a smart contract that would comply with legal standards. In particular, we
recommend the following areas of future research:
1. The possibility to include a legal agreement as a hash-code in the smart contract (de facto adding a vetted legal document alongside the code in the smart contract). 2. Research on legally-sufficient identification of smart contracting parties.
Keywords: blockchain, smart contracts, legal requirement for an agreement, sale of
movable goods within the EU, applicable law for the smart contract, competent court, design legal smart contract.
Content
To What Extent is it Possible to Build a Blockchain-Powered Smart
Contract that Establishes and Executes an International Sale of
Movable Goods Agreement and is in Compliance with the Laws
Governing Contracts?
Acknowledgement 2
Abstract 3
Introduction 9
Research Approach 11
SECTION 3 Blockchain Technology FRAMEWORK
3.1.1 Solving the Double-Spending Problem 13
3.1.2 The Evolution of Blockchain Technology Away from Bitcoin 15 3.1.3 Sample Uses of Blockchain that Do Not Involve Bitcoin or
Other Cryptocurrencies 16
3.2 Blockchain Technology: How Does it Work 16
3.2.1 Sign a Piece of Information 17
3.2.2 Distribute the Signed Information Across a Network 20 3.2.3 Whait For the Nodes to Verify the Information and the Signature 21
3.2.4 Creation of a Block 21
3.3 Blockchain Characteristics 22
3.3.1 Sub-conclusion 25
3.4 Technical Limitations in the Blockchain Technology 26 3.4.1 Limitation 1: Issues Related to the Architectural Design
of the Blockchain Technology 26
3.4.2 Limitation 2: Security and Exploitation Issues 27 3.4.3 Limitation 3: Security vs. Decentralized Consensus 28 3.4.4 Limitation 4: General Issues Behind the Blockchain Technology 28
3.4.5 Limitation 5: Conflict of Principles 30
3.5 Public vs. Private Blockchain 30
SECTION 4 SMART CONTRACT FRAMEWORK 31
4.1 Smart Contract 32
4.2 Smart Contract Example 33
SECTION 5 Smart Contracts in the Legal Field of Private International Law 36
5.1 Case Study: Traditional International Sale Agreement 38 5.1.1 Question 1: Is the Court of Maastricht Competent
[In the absent of choice of forum 40
5.1.2 Question 2: Which Law is Applicable?
[In the absent of choice of forum] 42
5.1.3 Question 3: Choice of Law 43
5.1.4 Question 4: Choice of Forum 47 5.2 International Sale Agreement in a Smart Contract 52 5.2.1 The International Character of Smart Contracts 53 5.2.2 General Approach of Translating Legal Clause into a Logic System 54 5.2.3 Answering the Same Three PIL- questions,
while using Smart Contract as an Agreement 57
5.2.4 Technical Solutions to (Prevent) Breach of Contract 59
5.2.4 Escrow Transactions 60
5.2.4 Efficient Micro-Payments 61
5.2.5 New Types of Conflicts Related to the Use of Smart Contracts 63
Sub-conclusion 64
Section 6 Building a Prototype Legal Smart Contract 65
6.1 Providing a Legal Framework for the Existence of a Contract According
to the Chosen Applicable Law (Dutch Contract Law). 66 6.2 Illustrating the Prototype Legal Smart Contract in a Flowchart 72 6.3 Legal Elements of the International Sale Agreement Translated into a Code 74
Legal Element 1 Offer 74
Legal Element 2 Acceptance 74
Legal Element 3 Acceptance under Condition (Time) 76
Legal Element 4 Rejection & Withdrawal 79
Legal Element 5 Termination 80
Legal Element 6 Mutuality 81
Legal Element 7 Contract Form Requirements 81
Legal Element 8 Identification of the Signing Parties 84
Legal Element 9 Applicable Law 84
Legal Element 10 Competent Court 86
Section 7 Evaluation 88
7.1 What Type of Legal Work Can be Replaced by Smart Contracts? 88
7.1.1 Legal Work that Establishes Trust 90
7.1.2 Exchange and Transfer of Assets 89
7.1.3 Repeatability of Legal Work 90
7.2 Challenges Related to Coding a Legally Viable Contract as a Smart Contract 90
7.2.2 Specific Technical Limitations that May Affect Legal Adoption of Smart Contracts 91
7.2.3 Limited Space 91
7.2.4. No Time Mechanism Built Into the Design 92
7.2.5. No Exception Handling 93
7.3 Future Role of a Legal Expert 93
Conclusion 94
Bibliography 96
Appendix I Solidity Script Prototype Legal Smart Contract Appendix II Overview of Some of the Smart Contract Platforms
I Introduction
The past decade has seen the rapid rise in interest in the Bitcoin, blockchain, and smart
contract technological platforms.1 In a 2018 analysis, Bloomberg estimated the value of blockchain technology at $700 million USD, and the total value of cryptocurrencies at over $385 billion USD.2 The World Economic Forum (WEF) predicts that by 2027, 10 percent of global GDP will be stored on blockchain, collectively representing a market value of $50 trillion.3 The WEF further predicts that nine out of ten business will implement some form of blockchain technology in their business model by 2022.4 Some business sources5have gone so far as to claim that blockchain technology is one the most disruptive emerging
technologies as measured by its potential to change established political, economic, social, legal and technological structures.6
At its core, blockchain technology – which was originally invented as the foundation of the digital currency Bitcoin – allows users to record information in a permanent and immutable way across a network of computers. In recent years, blockchain (and the related concept of smart contracts) have proven capable of recording not only monetary transactions, but also any form of information, including “birth and death certificates, marriage licenses, deeds and titles of ownership, educational degrees, financial accounts, medical procedures, insurance claims, voting, provenance of food” 7 and much more.
In recent years, as the need to educate and serve clients adopting this disruptive technology has grown, major law firms have begun to expand their interest in blockchain technology.8 In order for legal experts to understand how this technology will affect their own sector,
1 Olga Kharif, ‘Blockchain, Once Seen as a Corporate Cure-All, Suffers Slowdown’ (2018) in Bloomberg <
https://www.bloomberg.com/news/articles/2018-07-31/blockchain-once-seen-as-a-corporate-cure-all-suffers-slowdown> accessed 10 August 2018.
2 Lionel Laurent, ‘What Bitcoin Is Really Worth May No Longer Be Such a Mystery’ (2018) in Bloomberg
< https://www.bloomberg.com/news/articles/2018-07-31/blockchain-once-seen-as-a-corporate-cure-all-suffers-slowdown> accessed 18 August 2018.
3 Margaret Leigh Sinrod, ‘Still don’t understand the blockchain? This explainer will help’ (2018) in World Economic
Forum < https://www.weforum.org/agenda/2018/03/blockchain-bitcoin-explainer-shiller-roubini/> accessed 10 August 2018.
4 Margaret Leigh Sinrod, ‘Still don’t understand the blockchain? This explainer will help’ (2018) in World Economic
Forum < https://www.weforum.org/agenda/2018/03/blockchain-bitcoin-explainer-shiller-roubini/> accessed 10 August 2018.
5 Don Tapscott, Alex Tapscott, Blockchain Revolution: How the Technology Behind Bitcoin and other Cryptocurrencies Is
Changing the World (2016) p. 80-89.
6Don Tapscott, Alex Tapscott, Blockchain Revolution: How the Technology Behind Bitcoin and other Cryptocurrencies Is
Changing the World (2016) p. 80-89.
7 Don Tapscott, Alex Tapscott, Blockchain Revolution: How the Technology Behind Bitcoin and other Cryptocurrencies Is
Changing the World (2016) p. 5-12.
lawyers and legal experts must understand the technological abilities and limitations of the blockchain technology. This paper arose out of this need and the ensuing desire to present a Legal-Tech thesis aimed at legal experts. This thesis is a product of a cooperative effort between the author, a master’s student in commercial law, and a veteran programmer with over two decades of programming experience at Microsoft.
The purpose of this thesis will be to answer the following question:
To What Extent is it Possible to Build a Blockchain-Powered Smart Contract that Establishes and Executes an International Sale of Movable Goods Agreement and is in Compliance with the Laws Governing Contracts?
This paper is divide into five sections: A. Blockchain Technology Framework B. Smart Contract Framework
C. Legal Framework D. Application E. Evaluation
In the next Section, I provide an overview of the research approach of this paper and a summary of what to expect in each section.
II Research Approach Current state of research
Much has been written on how the blockchain technology and, in particular, smart contracts work and many law firms and other legal experts publish articles on the blockchain
technology on their website. Most legal experts discuss how smart contracts may affect the legal sector. However, most of the knowledge is based on theory and predictions of possible use cases, rather than empirical research. As a consequence, there is a lack of a real life smart contract that is built on the principles of law. This paper seeks to address this gap by presenting a multidisciplinary analysis.
The Smart Contract Workgroup of the Dutch Blockchain Coalition has recently published a paper on the use of blockchain for legal purposes. In that paper they discuss a number of general legal issues that may arise while using smart contract in the context of Dutch law. The research made by the Dutch Blockchain Coalition is a theoretical research, rather than an empirical research. The aim of their research was to raise theoretical issues rather than provide empirical proof of a legally-compliant smart contract.
Research objective
My main purpose is to build on existing work by presenting an interdisciplinary thesis aimed at lawyers seeking to understand the intersection between blockchain technology and
contract law. The secondary audience of this paper includes programmers interested in understanding some of the legal issues affecting this new technology. In either case, both parties benefit from an interdisciplinary approach. In particular, if and when attorneys are to broadly adopt smart contracts for legal purposes, then it is in the interest of all parties for lawyers to understand the basic principle behind blockchain coding. Similarly, programmers and product managers benefit from being informed as to what code should contain in order to make smart contracts legally enforceable.
Research method
To realize my research objective, I will provide a technical example of a smart contract and the legal and technological context needed to understand it. I do so across five sections, starting with the next section (Section 3). In particular:
Section 3: Blockchain Technology Framework provides an introduction to blockchain
technology, explains how this technology works, as well as its possibilities and limitations.
Section 4: Smart Contract Framework adapts the discussion in Section 3 to the specific
case of the smart contract (an applied form of blockchain technology).
Section 5: Legal Framework reviews the general elements of Private International Law and
discusses the traditional International Private Law sources that may apply to a specific case-study. This section will particularly focus on three crucial questions:
1. Which Court is competent to give judgement?
2. What law is applicable to govern the legal relationship between the contracting parties? 3. What is the legal framework to choose the applicable law and the competent court?
Section 6: Application combines the technical and legal context in the preceding three
sections by presenting a programming script for a prototype smart contract designed as part of this thesis. The smart contract is discussed in detail in this section, and the entire code is included in Appendix I
Section 7: Evaluation evaluates the process of encoding legal conditions into programming
code. In addition, I explain, which type of legal work is most likely to be affected by smart contracts and discuss how the role of the lawyer may evolve in a future where blockchain technology and smart contracts supplement existing legal work.
Section 3 BLOCKCHAIN TECHNOLOGY FRAMEWORK
The purpose of this section is to explain what blockchain technology is and how it works. Blockchain technology was first introduced in 2008 by Nakamoto in a paper titled
“ Bitcoin: A Peer-to-Peer Electronic Cash System”. In the paper, Nakamoto introduced the concept of Bitcoin, a platform built on blockchain technology that enables users to transfer cryptocurrencies without the engagement of a bank. Blockchain technology powers the exchange of digital currency using Bitcoin, but in recent years has been adapted to allow for the exchange and storage of any type of information.
This section is structured as follows. In Section 3.1, I provide a general overview of blockchain technology, explaining why it emerged and what its main purpose is (that is, what problem was it designed to solve?). In Section 3.2, I explain how blockchain technology works in general terms. In Section 3.3, I explain how blockchain technology works from a more technical perspective, examining the technical architectural design of the blockchain technology and reviewing possible issues and limitations.
Section 3.1 General Introduction to the Blockchain Technology 3.1.1 Solving the Double Spending-Problem
Just as Isaac Newton designed calculus in the service of explaining Newtonian physics, technologies often emerge out of a need to solve a certain problem. The underlying technology of blockchain was designed to solve a specific problem faced by the digital currency Bitcoin: how to design a new digital currency that prevents users from spending the
same digital currency twice without a centralized authority to monitor and record transactions and balances. This is referred to as the double spending problem.
Traditionally, banks keep track of all the transactions of their clients in a ledger that is closed off to the public. Banks verify and control whether a party spends the same money only once and not twice or multiple times. They also maintain balances and limit customers from spending money they do not have. By contrast, the founder of Bitcoin in his paper [“ Bitcoin:
A Peer-to-Peer Electronic Cash System”.] wanted to establish a way for individuals to make money transactions in the absence of a centralized authority.9
The founder introduced Bitcoin, a form of a digital currency (specifically, a cryptocurrency) alongside an alternative way to execute electronic payments and solve the double-spending problem called blockchain. Blockchain replaced the role of a bank as a trusted third party managing and recording transactions with a public ledger that is secured using cryptography. In particular, the public ledger is a record of information that is stored across multiple
computers (“nodes”) on a network (such as the Internet), where the information is transferred and broadcast to other nodes using peer-to-peer technology. More specifically, instead of having a centralized power (such as a bank) that checks whether a party has the minimum balance to complete the transaction, blockchain technology allows each node to verify the public ledger that is maintained across the network of nodes. As Nakamoto describes in their paper,
“To accomplish a valid and updated ledger, without a trusted party, transactions must be publicly announced in a system where participants can agree on a single history of the order, in which they were received. The payee needs proof that at the time of each transaction, the majority of nodes agreed it was the first received.”10
Just like fiat currencies, cryptocurrencies need to be secured to prevent malicious users from changing the public ledger, as well as to prevent double-spending.11 Cryptocurrencies and blockchain technology in general are secured using mathematical principles known as cryptography and hashing. These principles are the basis of the security underlying
blockchain technology.12 They are based on complex mathematical puzzles that are beyond the scope of this paper but subject to considerable interest in their respective academic disciplines.13
9 Satoshi Nakamoto, ‘Bitocin: A Peer-to-Peer Electronic Cash System’ [2008], p. 2-5.
< https://bitcoin.org/bitcoin.pdf > accessed January 2018.
10 Satoshi Nakamoto, ‘Bitocin: A Peer-to-Peer Electronic Cash System’ [2008], p. 2-5.
< https://bitcoin.org/bitcoin.pdf > accessed January 2018.
11 Arvind Narayanan and others, Bitcoin and cryptocurrency technologies (2016), p. 35-43. 12 Arvind Narayanan and others, Bitcoin and cryptocurrency technologies (2016), p. 38-49. 13 Arvind Narayanan and others, Bitcoin and cryptocurrency technologies (2016), p.38-42.
3.1.2 The Evolution of Blockchain Technology Away from Bitcoin
Since 2014, the use of blockchain has expanded beyond the world of cryptocurrencies (See Figure I below). In particular, blockchain’s public ledger - the record of information stored across a network that enables the use and transfer of cryptocurrencies like Bitcoin - has since been adapted to contracts, financial arrangements, and identity management, among other uses.14 The advantages of blockchain technology have proven attractive because it allows information to be transparent and public while simultaneously being safe, permanent and efficiently stored. In addition, blockchain technology can eliminate costly intermediaries by providing trust, transparency, and accountability at the same time. For example, traditionally, banks, lawyers, and other third party agents have been employed to record, control and validate transactions. In its many applicants, blockchain has allowed innovative institutions and companies to replace these third parties with a public ledger distributed across multiple nodes, which reach consensus in order to record and execute a transaction.
Figure I Stages of blockchain technology adoption, by Swan, Blockchain: Blueprint for a New Economy, 2015.
14Melanie Swan, Blockchain, Blueprint for a New Economy (2015), p. 5.
3.1.3 Sample Uses of Blockchain that Do Not Involve Bitcoin or Other Cryptocurrencies
The adoption of the blockchain technology is still in progress and its adoption in multiple sectors is still been researched. However, most of blockchain initiatives have taken place in the following sectors: Retail15, Insurance16, Healthcare17, Supply chains and logistics18, Governmental services19 and Real Estate20.
Section 3.2 Blockchain Technology: How Does it Work?
This Section provides a practical roadmap of how blockchain technology works. I review the sequential characteristics of the technology and explain how it enables information or data to be processed on the blockchain platform. As noted above, there are many reasons why people would want to use blockchain technology to process data, including the creation of a smart contract between two parties, storing important information across a network, or posting dated information that serves as proof of a particular event. Later in this paper, I review in detail one specific application of blockchain technology: the smart contract
15Warranteer—‘A blockchain application that allows consumers to easily access info regarding the products they purchased
and get service in the case of product malfunction’.
Source: https://www.forbes.com/sites/bernardmarr/2018/05/14/30-real-examples-of-blockchain-technology-in-practice/#4ffa1274740d, accessed 20 August 2018.
16Accenture—‘With goals to boost efficiency and productivity within the insurance industry, Accenture builds blockchain
solutions for its insurance clients. They translate key insurance industry processes into blockchain-ready procedures that embed trust into the system’. Source: https://www.forbes.com/sites/bernardmarr/2018/05/14/30-real-examples-of-blockchain-technology-in-practice/#4ffa1274740d, accessed 20 August 2018.
17MedicalChain—‘The first healthcare company using blockchain technology to facilitate the storage and utilization of
electronic health records in order to deliver a complete telemedicine experience. They are real practicing doctors in the UK healthcare structure and want to change the system from within’.
Source: https://www.forbes.com/sites/bernardmarr/2018/05/14/30-real-examples-of-blockchain-technology-in-practice/#4ffa1274740d, accessed 20 August 2018.
18IBM Blockchain—‘Knowing the status and condition of every product on your supply chain from raw materials to
distribution is critical. Blockchain for supply chains allows transparency with a shared record of ownership and location of parts and products in real time’.
Source: https://www.forbes.com/sites/bernardmarr/2018/05/14/30-real-examples-of-blockchain-technology-in-practice/#4ffa1274740d, accessed 20 August 2018.
19Estonia – ‘The Estonian government has partnered with Ericsson on an initiative involving creating a new data center to
move public records onto the blockchain’.
Source: https://www.forbes.com/sites/bernardmarr/2018/05/14/30-real-examples-of-blockchain-technology-in-practice/#4ffa1274740d, accessed 20 August 2018.
20BitProperty—‘Using blockchain and smart contracts, BitProperty wants to democratize opportunity and create a
decentralized society by allowing anyone anywhere in the world (except the U.S. and Japan due to regulatory concerns) to invest in real estate’.
Source: https://www.forbes.com/sites/bernardmarr/2018/05/14/30-real-examples-of-blockchain-technology-in-practice/#4ffa1274740d, accessed 20 August 2018.
A Roadmap for Understanding The Technical Elements of Blockchain
The technical procedure of processing information on the blockchain platform has a fixed order. In particular, to record information on a blockchain, a user must:
1. Sign a Piece of Information
2. Distribute the Signed Information Across the Network (Across the Nodes) 3. Wait for the Nodes to Verify the Information and the Signature
If all three steps are completed, the information will be stored in a block (that is, a permanent and verified record distributed across a network by the blockchain platform). Below, I
explain how this process works.
3.2.1 Sign a Piece of Information
A critical part of the blockchain specification is the digital signature. The digital signature is intended to replace the handwritten signature of a person on a specific document.21 From a traditional legal point view a handwritten signature is a confirmation of a certain agreement, (i) which is signed only by the specific party; (ii) anyone who sees that written signature will be able to verify who signed it; and, (iii) no one other than the signer should be allowed to use the signature.22 Digital signatures use cryptography to achieve the same desired effect as a handwritten signature. Consequently, transactions in the blockchain are only valid and correct if the responsible party signs the transaction with its digital signature using a cryptographic technique.23
Digital Signatures: A General Explanation
Signing and verifying transactions within the blockchain technology works using public and private cryptographic keys.24 As Nakamoto describes in his paper, there are two keys
provided to each user of the blockchain platform. One of the keys is open to the public and everyone can see it (public Key). The other key is a secret key associated with the public key (private Key). No one except for the owner of the Public Key has access to that Private Key. By contrast, the Public Key serves as a user’s virtual identity and is shared with the
21 Arvind Narayanan and others, Bitcoin and cryptocurrency technologies (2016), 37-42. 22 Arvind Narayanan and others, Bitcoin and cryptocurrency technologies (2016), 37-42. 23 Arvind Narayanan and others, Bitcoin and cryptocurrency technologies (2016), 37-42. 24 It was first proposed by Rivest, Shamir and Adleman, February 1978. (RSA –algorithm).
Source: Rivest and others, ‘A Method for Obtaining Digital Signatures and Public-Key Cryptosystems’, in National Science Foundation grant <https://people.csail.mit.edu/rivest/Rsapaper.pdf> accessed August 2018.
public.25 As an analogy, public and private keys can be compared to debit card numbers and debit card pins, respectively. Whereas the debit card number is visible publicly every time a user pays with their debit card, the pin code is private and is required to verify the use of the debit card. As with debit cards, users can create multiple public identities, each associated with a public key.26 And as with debit cards, each Public Key is accompanied by a separate Private Key. As a consequence, users can sign different statements of information intended for the blockchain using different Public keys (identities).27In each case, a user must use their private key to identify that they are the ones making the transaction on behalf of the associated Public key.
Notably, due to this decentralized identity management, blockchain technology creates anonymous and private identities.28 Some authors have pointed out that this can easily facilitate money-laundering practices, because in the absence of a central authority, there is no arbitrating force that can determine which public virtual identities belong to which real world identities.29 Some experts have responded by noting that while Public keys may not be associated with a recognized identity, it may be possible to recognize certain patterns coming from one virtual identity. In other words, ‘the identity that someone creates makes certain statements and the pattern of that behaviour might itself be identifying’.30
Figure 2 The function of the private and public keys [based on the explanation
of Nakamoto, 2008, p. 4
25 Arvind Narayanan and others, Bitcoin and cryptocurrency technologies (2016), p. 48. 26 Arvind Narayanan and others, Bitcoin and cryptocurrency technologies (2016) p. 4.8 27 Satoshi Nakamoto, ‘Bitocin: A Peer-to-Peer Electronic Cash System’ [2008], p. 5.
< https://bitcoin.org/bitcoin.pdf > accessed January 2018.
27 Arvind Narayanan and others, Bitcoin and cryptocurrency technologies (2016), p. 53.
28 Daniel Drescher, Blockchain Basics, A Non-Technical Introduction in 25 Steps (2017) p. 97-103. 29 Arvind Narayanan and others, Bitcoin and cryptocurrency technologies (2016), p. 53.
Digital Signatures: A Technical Explanation
The section below explains how blockchain technology uses algorithms to create digital signatures, Public keys (Pk), and Private/Secret keys (Sk). In particular, blockchain uses an algorithm, generateKeys, to randomly generate a Public key and Secret key (a key pair) for each user, based on a certain level of complexity (the keysize). A user can combine his or her Secret key with a message using the sign algorithm to generate digital signature (sig). Finally, given a message, a signature, and a Public key, any third party can verify whether a message is valid by processing these three values through a verify algorithm, that will produce either a “true” or “false” result depending on whether the signature was produced using the right secret key.
The complete signing and the function of each type of key is worked out in the collective work on the Bitcoin and blockchain technology by Princeton University, Bitcoin and
cryptocurrency technologies and look as follows:
Digital signature scheme. A digital signature scheme consists of the following three algorithms:
1 (sk, pk) := generateKeys(keysize) The generateKeys method takes a key size and generates a key pair. The secret key sk is kept privately and used to sign messages. pk is the public verification key that you give to everybody. Anyone with this key can verify your signature.
2 sig := sign(sk, message) The sign method takes a message and a secret key, sk, as input and outputs a signature for message under sk
3 isValid := verify(pk, message, sig) The verify method takes a message, a signature, and a public key as input. It returns a boolean value, isValid, that will be true if sig is a valid signature for message under public key pk, and false otherwise. We require that the following two properties hold:
● Valid signatures must verify
verify(pk, message, sign(sk, message)) == true
● Signatures are existentially unforgeable
Figure 3 the function of the keys, and the validity of a signature
[based on the explanation of Nakamoto, 2008, p. 4] 31
31 Arvind Narayanan and others, Bitcoin and cryptocurrency technologies (2016), p 38.
Figure 4 The public key on Ethereum
Figure 4 shows how the hashed Public key may look like on Ethereum. As this picture shoes, the entire Public identity consists out of random algorithm numbers.
3.2.2 Distribute the Signed Information Across a Network
After a user signs some information (for example, on the Bitcoin platform, this could be a request to transfer money from themselves to another user), the blockchain platform
broadcasts the signed data to all the computers that are connected to the blockchain network using peer-to-peer technology (that is, instead of a using a centralized server to distribute the information to other computers, computers broadcast the information among themselves until a critical mass of computers has received the information).32
As an example, an individual may wish to complete a last will and testament, signing the document and broadcasting it to ensure that the document is stored across nodes on the network and cannot be modified or forged. Broadcasting the signed will and testament across a network of nodes using blockchain technology would make it possible to record the
document in a public ledger while reducing or eliminating the possibility that it can be modified, lost, or forged. In this scenario, the role of a “trusted third party”, such as the notary or witnesses, could in theory be replaced by the blockchain computer network. (Note that the privacy of information broadcast using blockchain technology will be discussed in Section 3.5).
3.2.3 Wait For the Nodes to Verify the Information and the Signature
Once signed data is broadcast across the decentralized peer-to-peer network, individual computer (nodes) on the network verify the validity of the signature using the
aforementioned verify algorithm. If the data is valid, nodes compare it to the information received by other nodes. If the majority of nodes received and validated the same
information, this means there is consensus among the nodes. In this case, the nodes accept the information; it will eventually be added to the blockchain’s public ledger through a process referred to as the creation of a block (see below).33
The verification process is meant to prevent malicious nodes from introducing information that they claim has been signed but that the majority of nodes (which must not be malicious) have not verified as signed.34 In this case, because the majority of nodes have not verified the data from the malicious node as correct, consensus is not reached and the information should not be added to the blockchain’s public ledger.35
3.2.4 Creation of a Block
Based on consensus, one of the competing blocks will be chosen and hence will be
considered a valid block. Each block contains different transactions that were executed in the same time-frame. In addition, in order to prevent users from adding blocks or changing their order, the block will be “hashed” in accordance with certain cryptographic algorithms.36 Hashing can be described as a very complicated mathematical puzzle that makes hacking the ledger very difficult, because each block is uniquely tied to the previous block (this is the “chain” part of the blockchain). In particular, each block contains its own hash-puzzle, and the hash-puzzle of the previous block. Due to the cryptographic secure hash-code, the history of all the blocks, including the history of all the inside transactions are record and cannot be erased. 37 Eventually, this becomes a chain of connected blocks - the blockchain (Figure 5).
33 Daniel Drescher, Blockchain Basics, A Non-Technical Introduction in 25 Steps (2017), p. 150-170. 34 Arvind Narayanan and others, Bitcoin and cryptocurrency technologies (2016), p. 37-39.
35 Daniel Drescher, Blockchain Basics, A Non-Technical Introduction in 25 Steps (2017) p. 155-163. 36 Arvind Narayanan and others, Bitcoin and cryptocurrency technologies (2016), p. 64-66.
Figure 5 Elements contained in a block, based on the explanation of Nakamoto, 2008, p. 4
[Hash-code previous block + multiple transactions +timestamp+ current hash-code]
Section 3.3 Blockchain Characteristics
In the previous Section we discussed how a transaction on the blockchain comes to into existence. In this Section we review various specific characteristics of the blockchain technology in more detail in order to enable our later legal analysis.
In the 2017 journal Financial Innovations, Zhu and Zhou formulated an overview of the important characteristics and components of the blockchain technology38 in the process of analysing the use and the adoption of blockchain technology within the Chinese equity crowd funding market. Based on their overview we created a template that names and explains the main characteristics of the blockchain technology.
Characteristics Explanation
1. Peer to-Peer Broadcasting Network Each participating node receives the same information, all the nodes are equal, and there is no single node that is more important than the others. This principle of equality among the nodes and the distributed database are cornerstones of the blockchain technology. In particular, this feature enables redundancy because the entire database is distributed across multiple computers. In order to verify new transactions (in the process, creating new blocks), each node maintains a complete history of previous blocks that
38 Huasheng Zhu, Zach Zhizhong Zhou, ‘Analysis and outlook of applications of blockchain technology to equity
crowdfunding in China’ (2016) in Financial Innovations No.1 <https://link.springer.com/article/10.1186/s40854-016-0044-7 > accessed 20 July 2018.
are stored using a complicated mathematical key (called a hash).
2.Distributed ledger vs. transparency The distributed ledger brings
transparency as a feature, because each node connected to the decentralized network has a copy of all the transactions that are happening and transactions that took place in the past.39
Thus, everyone node has a copy of the blockchain.40 However, it is important to make a distinction between the
“transaction flows” and the users of blockchain. In particular, the
transactions are public, but the users can stay anonymous.
3. Decentralized data management Every node in the system has in principle the authority to add data to the ledger (in other words, add data to the blocks). In addition, each node has the possibility to create a block using the information transmitted by other nodes
if that node solves a pre-determined mathematical puzzle before the other nodes. Consequently, this characteristic
implies that no one user or node owns the system more than any other.41
4. Verification in a decentralized network Verification refers to a characteristic whereby nodes individually verify transactions and reach an agreement as to which transactions are legitimate and which are not. Moreover, anyone with a computer can theoretically participate in the network as a node to verify
transactions. Those who do that are called miners. Miners contribute in the verification process of blockchain because they have an incentive to receive some kind of reward (for example, payment in the form of a digital currency like Bitcoin) if they
39 Melanie Swan, Blockchain, Blueprint for a New Economy (2015), p. 38-56, 103-115. 40 Melanie Swan, Blockchain, Blueprint for a New Economy (2015), p. 38-56.
perform the verification process before the other miners. 42
5. Proof of Work Proof of Work is one way to verify
whether information transmitted using blockchain technology is valid (e.g. has been signed), and refers to miners using significant computer power to solve a very complicated mathematical problem and thus verify transactions.
The consortium43 overseeing the blockchain technology designed the mathematical problem in such a way that it is solvable approximately every 10 minutes for Bitcoin platform and 15 seconds for Ethereum. The node that solves the mathematical puzzle before the others will be the one that creates the next block (a compendium of the all information transmitted during that time interval) and receive a reward. As one might imagine, the number of miners tends to increase as a blockchain platform becomes more popular. However, the original platform employing blockchain technology, Bitcoin, was designed to make the problem being solved automatically more difficult in order to maintain a ten minute average interval between each block being added to the blockchain.44
6. Redefining “trust” Because of the Proof of Work method, parties do not need to trust each other. Verification is done through decentralized networks, where thousands miners verify the transaction.45
7. Immutability and tamper-proofing Immutability means that the blockchain (including the transactions within each block) cannot be altered or erased by a malicious user. This is because each block is tied together to the previous block using a cryptographic technique. This so-called “hash-puzzle” makes impossible to add or remove blocks because each block is related to the blocks around it using hashing. The decentralized nodes would immediately
42 Satoshi Nakamoto, ‘Bitocin: A Peer-to-Peer Electronic Cash System [2008], p. 4-6.
< https://bitcoin.org/bitcoin.pdf > accessed January 2018.
43 The Consortium has a way to adjust the difficulty and they do it to achieve certain average block creation speed. 44 Daniel Drescher,Blockchain Basics, A Non-Technical Introduction in 25 Steps (2017), p. 132-139.
notice a new, invalid hash code and reject it from the blockchain using voting in a process called forking.46
8. Consensus & Decentralized Decisions The verification system of approving or dismissing each transaction is a
technological application of a democratic system. The nodes, which are the
participants of the network, vote for which transaction they consider to be valid and correct. Based on consensus, they reach agreement and decide which transaction is correct and store that in the history of transactions (the blockchain).47
9. High efficiency Time and money-wise, blockchain
technology can be much faster and cheaper, than traditional existing services of trusted third parties. Appendix II contains an overview of certain blockchain platforms and their efficiency scales.
3.3.1 Sub-Conclusion
This section reviewed the key characteristics of blockchain technology. Digital signatures and some of the other technical elements discussed above are not, by definition, new technological concepts. However, one of the defining features of blockchain technology is how distributed ledgers on different computers replace trusted intermediaries. Establishing “trust” between parties has traditionally been perceived as both costly and time-consuming. In principle, blockchain allows for direct communication between signing parties without costly intermediaries. However, limitations and problems exist. The issues and limitations of blockchain technology are discussed in the next Section.
46 Daniel Drescher,Blockchain Basics, A Non-Technical Introduction in 25 Steps (2017)p. 138-142. 47 Daniel Drescher,Blockchain Basics, A Non-Technical Introduction in 25 Steps (2017)p. 137-145.
Section 3.4 Technical Limitations in the Blockchain Technology
For the purpose of this Section, we will look to and describe five limitations that currently exist in the blockchain technology. This Section focuses on technical issues and well-known coding limitations that could lead to adverse outcomes for lawyers or law firms using
blockchain technology.
3.4.1 Limitation 1: Issues Related to the Architectural Design of the Blockchain Technology
What is scalability?
In software engineering, scalability of the computing system means that to serve twice as many users we simply need to double the computing power. If the computing demands grow faster than the number of users (transactions), such systems are called non-scalable.
Systems in the real life may need to be scalable in order for it to keep up with the demand.
Scalability vs. Efficiency
As Dr. Andrzej Turski has explained, that the technical limitations of blockchain technology are eventually going to affect the efficiency of the technology with respect to time and money. Efficiency in time and money is dependant on technical limitations. The more users use the blockchain technology, the more transactions will take place. As currently stated on the official Bitcoin website, there are about 2,020 transactions per block, and it takes 600 seconds (10 minutes) to create a block, so the blockchain technology process about 3.37 transactions per second.48
This is a very small number compared to the VISA credit card payment platform, which is capable of processing about 1,700 up to 24,000 transactions per second.49 As the number of transactions per second grows, so is the peer-to-peer traffic and the storage requirement (remember: each full node stores the complete history of all transactions since the beginning of blockchain). This is even more a problem for smart contracts (Ethereum blockchain), where each node not only stores the complete history of all transactions, but also executes the code of all new incoming transactions. This won’t scale as the adoption widens. In other words, the blockchain technology is not scalable, because even though there may be more
48https://www.bitcoinplus.org/blog/block-size-and-transactions-second.
nodes added to the network, each full node still has to do the same work and store even more information independently. In order to change that, the entire architecture of blockchain would have to change.50
Scalability vs. Proof-of-work
Block creation on Bitcoin is designed to take about ten minutes. However, due to the increased popularity of blockchain technology, the number of Bitcoin miners is increasing. Because the system still requires approximately ten minutes for block creation, the
mathematical puzzle being solved (proof of work) is automatically scaled to become more and more difficult. As a result, the amount of electricity and computing power being used for mining has increased dramatically in the world’s most well-known blockchain (that used for Bitcoin).51 However, there are some discussions on how to replace the Proof-of-work mechanism in the blockchain. A number of coders argue that verification of transactions could be replaced with Proof-of-stake or Proof-of-trust.
Proof-of-stake means that nodes have an incentive to verify valid transactions, because the nodes have to make the right consensus decisions because they have a stake to lose. With regards to Proof-of-trust, that refers to a system that is “been trained” to recognize certain transaction patterns as valid.52
3.4.2 Limitation 2: Security and Exploitation Issues
Blockchain is based on programming code. As a result, blockchain technology is a
deterministic program that only does what it is programmed to do beforehand.53 If there is a problem in the code, this could create vulnerabilities affecting the integrity of the
information being placed in the blockchain. This is especially true if a malicious user discovered a new exploit or vulnerability.54
Additional security problem arises in the blockchain technology is a consequence of its decentralized and open-source nature. In particular, the code behind blockchain technology is publicly available to anyone. Malicious individuals could (and do) download this code to
50 Daniel Drescher,Blockchain Basics, A Non-Technical Introduction in 25 Steps (2017), p. 123-138.
51 Don Tapscott, Alex Tapscott, Blockchain Revolution: How the Technology Behind Bitcoin and other Cryptocurrencies Is
Changing the World (2018), p. 26-33.
52 Don Tapscott, Alex Tapscott, Blockchain Revolution: How the Technology Behind Bitcoin and other Cryptocurrencies Is
Changing the World (2018), p. 28-34.
53 Jesse Yli-Huumo and othters, ‘Where Is Current Research on Blockchain Technology?—A Systematic Review’ (2016)
Journal.Plos No 11 https://doi.org/10.1371/journal.pone.0163477, accessed August 2018.
examine it for bugs that could enable an attack. In addition, as mentioned before, there is no centralized repository of blockchain code. Therefore, it takes much longer to rectify and fix problems in the code, with bug fixing being in essence outsourced to a network of volunteers. The approach differs from many traditional trusted third parties, such as banks, whose code is not open to the public and is instead centralized and stored in a secured depository. If there is a bug in the code of a bank, then they can shut down and fix their system. On the
blockchain platform, this is more difficult, since the entire technology is running on multiple computers around the world. That said, there have been a number of recent successful attempts to make permanent changes/improvements to blockchain technology (so called “hard forks”) that have resulted, for example, in multiple different types of semi-competing Ethereum platforms.
3.4.3 Limitation 3: Security vs. Decentralized Consensus
Swan describes the dangers of a so-called 51-percentage attack. As previously described, participating blockchain nodes have to vote on each transaction. If the majority of the nodes (>50 percent) decide to deliberately or erroneously vote on a malicious block, then that block would come to existence and be marked as correct (that is, “verified).55 If more than fifty percent of the nodes are malicious and work together to vote on incorrect blocks/transactions, they can add information to the blockchain that is not legitimate, causing untold havoc to a system that manages billions of dollars worth of value.56 However, such an attack would be nowadays very difficult on well-established public blockchain networks, such as Bitcoin or Ethereum, but it did happen on smaller Ethereum test networks, and it may be a peril for isolated private networks.
3.4.4 Limitation 4: General Issues Behind the Blockchain Technology No Central Authority
One of the essential characteristics of blockchain technology is its effort to cut out
intermediaries and replace them with decentralized consensus. However, this decentralized mechanism becomes a problem if there is a need for decision-making on larger scale (For example, changes to proof-of-work or block sizes or consensus rules).57. There is no central power that can enforce the new rules.
55 Daniel Drescher,Blockchain Basics, A Non-Technical Introduction in 25 Steps (Apress, New York 2017)p. 208-210. 56 Melanie Swan, Blockchain, Blueprint for a New Economy (2015), p. 80-85.
Mining pools and Consensus
As explained before, mining is the process of verifying and recording transactions while seeking compensation for the work. If a transaction is sent to the network, then the nodes working on the network, have to vote on whether the transaction is valid. In practice, most of the small miners unite themselves in mining pools, which “are groups of cooperating miners
who agree to share block rewards in proportion to their contributed mining hash power. While mining pools are desirable to the average miner as they smooth out rewards and make them more predictable, they unfortunately concentrate power to the mining pools Owner”.58
As a consequence, the four current biggest mining pools - BTC.com, AntPool, ViaBTC and Slush Pool – collectively represent about 53 percent of the computational power in the Bitcoin blockchain as of this report. Even though in theory voting and verification takes place by individual miners through decentralized consensus, in practice the majority of verification is done via the four aforementioned mining pools. Figure 5 illustrates this consolidation. 59
Figure 6 Different mining-pools 2018, published on Bitcoin Official webpage.
58 Daniel Drescher,Blockchain Basics, A Non-Technical Introduction in 25 Steps (2017), p. 143-150. 59https://www.buybitcoinworldwide.com/mining/pools/.
3.4.5 Limitation 5: Conflict of Principles
The privacy and anonymity crisis inherent in blockchain technology has proved to be a mixed blessing. On the one hand, anonymity could lead to unwanted activities, such as money laundering. On the other hand, transactions are publicly accessible. For transactions that were executed on Ethereum for example, this means that by default everyone can see how much cryptocurrency has been transferred from one user to another. The public can also see at what time and when the transaction was made. 60 This combination of anonymity and transparency is a central feature of blockchain technology.
3.5 Public vs. Private Blockchain
One of the solutions to minimizing the privacy issues with blockchain is found in private
blockchains. Unlike public blockchains, the transactions in the in private blockchains are not
publicly visible and the owner of the blockchain can control who is allowed to participate in the network.61 Since 2017, there are various initiatives aimed at solving the privacy issue on public blockchain platforms, one of them being the zero-knowledge proof (zn-SNARK) that is now primarily applied on the Ethereum platform.
60 Daniel Drescher,Blockchain Basics, A Non-Technical Introduction in 25 Steps (2017), p. 206. 61 Daniel Drescher,Blockchain Basics, A Non-Technical Introduction in 25 Steps (2017), p. 93-101.
SECTION 4 SMART CONTRACT FRAMEWORK
In previous section, we provided general overview of what blockchain technology is and how it works. In this section, I examine how this technology could affect and eventually be used in the legal sector. The focus will mainly be on the smart contract application, which is a specific application of blockchain technology that allows execution of a computer code as a part of the recorded transaction.
Section 4.1 below defines smart contracts and discusses the technical abilities and limitations of a blockchain-powered smart contract. In Section 6 I demonstrate a custom prototype smart contract that is consistent with legal standards explained in sections 5. The section reviews certain parts of the code, as they will later relate to the legal characteristics of a smart contract.
4.1 Smart Contract
Cryptographer Nick Szabo published a paper in 1996, “Smart Contracts”62, wherein he explained how traditional contracts could be replaced with “a set of promises agreed to in a meeting of the minds, which is the traditional way to formalize a relationship,” and “could be transformed and translated into programming code.” 63
Szabo imagined that traditional contracts could be eventually redefined “as a set of promises, specified in digital form, including protocols within which the parties perform on the other promises”.64 He further argued that smart contracts would improve execution of the four basic contract objectives, which he described as “operability, verifiability, privity and
enforceability”.65 In a way, Szabo was initiating a change in the legal mind-set, from interpretation or analysis to a more logic-based thinking – in other words, a translation of legal conditions into codes that would look like a series of if -X-then-Y agreements.
62 Michael Gord, ‘Smart Contracts Described by Nick Szabo 20 Years Ago Now Becoming Reality’ (2016)
BitcoinMagazine https://bitcoinmagazine.com/articles/smart-contracts-described-by-nick-szabo-years-ago-now-becoming-reality-1461693751 accessed, June 2018.
63 Michael Gord, ‘Smart Contracts Described by Nick Szabo 20 Years Ago Now Becoming Reality’ (2016)
BitcoinMagazine https://bitcoinmagazine.com/articles/smart-contracts-described-by-nick-szabo-years-ago-now-becoming-reality-1461693751 accessed, June 2018.
64 Michael Gord, ‘Smart Contracts Described by Nick Szabo 20 Years Ago Now Becoming Reality’ (2016)
BitcoinMagazine https://bitcoinmagazine.com/articles/smart-contracts-described-by-nick-szabo-years-ago-now-becoming-reality-1461693751 accessed, June 2018.
65 Michael Gord, ‘Smart Contracts Described by Nick Szabo 20 Years Ago Now Becoming Reality’ (2016)
BitcoinMagazine https://bitcoinmagazine.com/articles/smart-contracts-described-by-nick-szabo-years-ago-now-becoming-reality-1461693751 accessed, June 2018.
Long before Szabo, the famous mathematician and legal scholar Leibniz also argued for a more logic-based theory for legal conditions. Leibniz wrote in the 17th century in Leibniz’
Doctrina conditionum, a logical theory of legal conditions and explained how legal concepts
could be framed into a mathematical and formal logical system.66 In other words, the interest in combining logical systems (modern day computer code) with law has been discussed with great interest for years. Blockchain technology is notable for introducing a technology that enables this idea to finally be executed in a rigorous and systematic way.
Defining Smart Contract
Smart contracts are based on blockchain technology, which was described in Sections 3.1 through 3.3. The challenges and limitations that affect blockchain technology, which are discussed in Section 3.4, also apply to smart contracts. Like blockchain technology, a smart contract is a software application that enables parties to broadcast information to be stored on a distributed network. In the case of smart contracts, this information forms a contract between parties. In particular, parties can decide to encode certain condition to their
transaction. Any type of information, such as legal agreements, legal conditions, or a transfer of a title of ownership, can be encoded in the transaction. Based on the recent literature review, smart contracts are explained as contracts that are “recorded in the blockchain and
executed (self-enforced) by distributed nodes of the network, which eventually eliminates the need for a trusted third party”.67
Deterministic Coding
Smart contracts are self- enforced and will be executed exactly as coded beforehand.68 They must be programmed beforehand, just like a contract must be drafted before being signed. Although emerging technologies promise to revolutionize the coding of smart contracts, as of 2018, the smart contract platform Ethereum is the most popular platform and uses the Solidity language to program smart contracts much as a Web developer building a website would write computer code. Indeed, Solidity is very similar to the well-known Web
66 Mathias Armgardt, ‘Leibniz as a legal scholar’ (2014) in HeinOnline
< https://heinonline.org/HOL/LandingPage?handle=hein.journals/fundmna20&div=11&id=&page>, accessed August 2018.
67 Jedrzejczyk & Marzantowicz,’ Distributed Ledger, Distributed Consensus and Their Impact on the Financial Services
Market’ (2016) in Cutter Business Technology Journal < https://www.cutter.com/article/distributed-ledger-distributed-consensus-and-their-impact-financial-services-market-493816>, accessed August 2018.
68 Jedrzejczyk & Marzantowicz,’ Distributed Ledger, Distributed Consensus and Their Impact on the Financial Services
Market’ (2016) in Cutter Business Technology Journal < https://www.cutter.com/article/distributed-ledger-distributed-consensus-and-their-impact-financial-services-market-493816>, accessed August 2018.
design language JavaScript, a common Web developing tool.69 Because smart contracts are coded, their outcome should be completely predictable; in particular, contracts leave no space for the subjective legal concepts such as “good faith” and “reasonableness.”
4.2 Smart Contract Example
The Ethereum website (at its core, a blockchain alternative to Bitcoin) offers several smart contracts samples. Most of these samples are for the execution o transfer of cryptocurrencies (including Etherium’ own digital currency).
It bears noting that most smart contracts available are designed to execute transactions, which are not necessarily legally binding. The smart contract built on Ethereum for example, are not built and programmed in accordance with the law. Hence, the question that
immediately arises – and forms the core of this paper – is whether it is possible to build a contract that would meet the basic elements of a mutual agreement as contained for example in article 6:217, paragraph 1 DCC.
4.2.1 Prototype Legal Smart Contract as an Example
Because no satisfactory example of legally compliant smart contract were located in the process of researching this paper, I provide in Section 6 an example of a smart contract that was designed exclusively for this paper. This smart contract is the product of a cooperative effort by a programmer, Andrzej Turski, and this paper’s author, a student of law.
The particular prototype legal smart contract that we built is based on a standard smart
contract established by Ethereum. It was built using Microsoft Azure Blockchain Workbench. The prototype smart contract will be based on a pre-programmed transfer of assets. Needless to say, in the context of the thesis, we will use this smart contract for demo purposes, without being bound to transfer assets on Ethereum.
69 Dutch Blockchain Coalition, ‘Smart Contracts als specifieke toepassing van de blockchain technologie’.
(Report June 2016).
Figure 7 Blockchain application: Uploading the smart contract code to Microsoft Azure Blockchain
Workbench.
Figure 8 Blockchain application: prototype smart contract, shows list of recorded transactions and the current
status of the smart contract.
The prototype smart contract that we built is focused primarily on establishing and
monitoring a simple agreement on price and condition between two parties. The purpose of our prototype smart contract is to illustrate which legal elements of a legal agreement can be
encoded using present-day smart contract technology, and which legal elements cannot. More specifically, we wanted to examine if it is possible to translate the legal requirements for the existence of a legal agreement, as referred to in the Dutch Civil Code, into a
programming code. In other words, is it possible to build a smart contract that complies with
the legal conditions for the existence of an agreement?
In the Evaluation section, we will review the final script of our prototype smart contract and discuss the findings. The complete Solidity script that was written in cooperation with a programmer is included in Appendix I. There, I provide additional guidance into how to read the code and what certain programming terms mean and why it is important for lawyers to understand them.
SECTION 5 Smart Contracts in the Legal Field of Private International Law
To eventually apply blockchain technology for legal purposes, the outcome of a smart
contract should be legally valid and enforceable. In this section, we will discuss the use of
smart contracts in the field of Private International Law (IPL). As mentioned in the
introduction, the aim of this thesis is to answer the question whether and to what extent it is
possible to build a Blockchain-Powered Smart Contract that establishes and executes an international sale of movable goods agreement, which is in compliance with Private International Law.
In section 5.1 I will discuss a specific case study and apply PIL.
In Chapter 5.2, I apply and discuss the same facts of the case study, but from the perspective of a smart contract. We will discuss what the difference is between traditional contracts and smart contracts for an international sale of goods agreement.
