March 22, 2016
The greatest promise for blockchain-enabled smart contracts is a highly efficient Internet of Things empowered by a web of agents, smart transactions, and contracts.
Somewhere among the distributed peer-to-peer marketplace enthusiasts, the bitcoin blockchain maximalists, and the banks fighting for their own place in the emerging digitized transaction environment, a class of crypto-lawyers is gaining prominence. In some cases, they’ve worked for decades on legally binding, computable code. Now they’re becoming the key influencers of new, blockchain-based smart contracts.
A smart contract is a digitally signed, computable agreement between two or more parties. A virtual third party—a software agent—can execute and enforce at least some of the terms of such agreements.
Nick Szabo, a computer scientist, legal scholar, and cryptographer, is a prime example. Szabo coined the term smart contract in 1993 and has been working since then on digital currency and computable contract language. His work has been foundational to what smart contracts are becoming in the blockchain era. Among Szabo’s many contributions to smart contracting is his 2002 “drafting language” for contract analysis that focused on reducing ambiguities and bolstering the logic in the terms of written agreements. That language built a bridge between legal terminology and procedural code. By doing so, Szabo managed to leverage the power of computation without abandoning the nuances of human language.
The scripting language used today in smart contracts echoes Szabo’s early efforts, but has taken a more graphical tack with protocols such as Ethereum, now available as part of Microsoft’s blockchain-as-a-service offering. The language of that protocol, called EtherScript, appears in modular, color-coded form to make it more human readable and intuitive, as in the following sales contract.
Source: “What is Ethereum?” EtherScripter, 2016, accessed January 7, 2016
The goal of contract scripting languages is to build on what already exists, but make it more interactive and more automated. Blockchain-based transactions are only the starting point for what could become quite elaborate, multiparty rule-based environments.
Due to the efforts of Szabo, the Ethereum project, and others, computable contract technology itself is not the obstacle. The true obstacle is human-centric legal processes that in some cases have been in place since ancient Rome.
What’s poised to emerge next would be just a step or two beyond what already has been developed. As such, it is an evolution, not a revolution. It helps to understand what precursors have existed and how they provide hints of what might be possible.
Precursors to smart contracts
To facilitate transactions, online shopping sites for decades have contained what are essentially one-way contracts. Most people are familiar with the terms of service of these sites. The terms are inflexible but generally suffice, especially for small-dollar transactions from reputation-ranked providers. The providers control the language in these terms of service statements. Shoppers must agree to them or shop elsewhere.
The level of verification possible for either side is relatively low. Shoppers either trust the merchant and the claims on its site—or not. Merchants for their part rely on credit card issuers to assume the risk of nonpayment.
Online transaction process management systems such as the Mortgage Electronic Registration Systems (MERS) are also precursors to smart contracts. MERS acts as a central, virtual mortgagee and simplifies the flows of changes among various parties and their roles in given mortgages.
Hybrid paper-plus-code contracts, or dual integration
Blockchains can of course verify the authenticity and versioning of document files, and that capability suggests a hybrid paper-plus-code model. The code can fully articulate the contract terms in machine-executable language, but the paper backup is also filed for the purposes of traditional recourse in the event of contract breaches and any resulting court actions.
Before founding smart contract vendor Eris Industries, CEO Casey Kuhlman and COO Preston Byrne practiced law. They understand the nature of the legal system’s dependencies on paperwork and acknowledge that many humans in the loop will be around for a while for legal purposes.
In a 2015 interview with PwC, Kuhlman pointed out, “If you were in a dispute with a counterparty and you tried to take a piece of smart contract code—even if it wasn’t machine readable, even if it was relatively readable code—if you were to take that to a court, the court would look at you like you were nuts. There would probably be five judges on earth who could look at the code and the data and then enforce it. That’s why we have this idea of dual integration.”
The table that follows outlines the numerous potential advantages of smart contracts. Readers should keep in mind that these advantages don’t always apply in every case.
The long-term vision
Dreamers and visionaries imagine a blue-sky future in which not only entire companies could operate in automated fashion (distributed autonomous organizations), but also a form of government (distributed autonomous government) and some aspects of society could be automated.
Within a web of contextualized smart contracts, it’s conceivable that software agents could be set up to dynamically manage each distributed autonomous organization. In a virtually normalized data environment, those agents could reach out and grab knowledge and other digital or digitally represented assets.
One example of such a web would be autonomous e-commerce. A fleet of self-driving trucks delivers goods to distribution centers. The robots at the distribution center sort and move those goods onto autonomous delivery drones. Then the drones make deliveries to end consumers. An end consumer, meanwhile, has some returns to make (such as shoes that don’t fit) and puts smart packages out for a drone to take back to the distribution center. Each step could be governed and executed by a web of smart contracts and one or more software agents acting as virtual third parties that have legal status.
It’s good to have long-term visions like these because they provide inspiration and direction. However, by 2020, only the simpler categories of smart contracts listed earlier seem feasible and are likely to materialize. In the 2020s, several of the simpler varieties of self-enforcing contracts could become possible at scale. Such a capability could eventually simplify compliance for whole categories of transaction types. But there are many obstacles in the path to adoption.
Key adoption challenges
There’s the dream of smart contracts, but then there’s the reality. Enterprises must overcome many different obstacles to transform the current transactional environment in so fundamental a way. While doing so, they will need to move down a steep learning curve.
Many roles inside the business ecosystem will need to be transformed. Lawyers must learn how to write computable code, and judges must learn how to interpret it, or rely on expert witnesses to testify to valid interpretations. Developers must bring into use the edgiest techniques from various disciplines. Confusion abounds about what the best techniques are, and awareness of the leading edge is low. The following list is a just a start of the kinds of obstacles to adoption that smart contracts confront:
- The reality of the adoption S curve. Adoption invariably follows an S-curve pattern, quite horizontally flat in the beginning, then turning vertical after some years.
- The lagging legal and regulatory environment. Regulations are among the least flexible and automated elements of the business ecosystem. Smart contracts themselves might suggest a starting point for tackling that problem, but there’s no simple solution, and exploring such a notion is beyond the scope of this article.
- The complexity of the business ecosystem. The installed base of business technologies, processes, and procedures reflects many assumptions that would need to be revisited when considering how to build smart contract capabilities into specific business processes.
- Competing but less advanced offerings. Peer-to-peer lending through software-as-a-service marketplace vendors, for example, is more mature and growing rapidly. The installed base of rule-based systems and other legacy IT also must be considered.
- Uncertainty surrounding best practices. What exactly are the best practices in smart contracts, and how will standards emerge? It’s unclear how smart contract code might embrace the advanced principles that enable the loose coupling articulated in the Reactive Manifesto or the message-driven programming practices in microservices, for example. Smart contracts are just now becoming viable, and one major issue is that many other ways to codify agreements already exist and are being used regularly.
Conclusion: The great promise and even greater challenges of smart contracts
It’s been more than 20 years since the launch of Amazon.com (as an online bookseller) and eBay (as AuctionWeb), and the birth of what became mainstream business-to-consumer (B2C) e-commerce. Recently, Forrester estimated that US online retail commerce reached $334 billion in 2015, amounting to just 10 percent of all retail sales, with year-on-year growth slowing to 8 percent by 2019. Similarly, Forrester estimated US business-to-business (B2B) e-commerce at $1.1 trillion in sales in 2015, just more than 12 percent of all US B2B sales, with year-on-year growth slowing to 6.7 percent by 2019.
To put historical developments within a context of the technological enablers necessary for e-commerce, Secure Sockets Layer (SSL) encryption was added to the Netscape browser in 1994, and Tim Berners-Lee introduced the first web browser in 1990. The TCP/IP networking protocol providing the basis for the Internet was first tested between two universities in 1975 and only explored reluctantly in corporate R&D labs beginning in 1984. Essentially, it took 20 years for the technologies enabling e-commerce to be developed and another 20 years for e-commerce to mature.
The Internet of Transactions, by contrast, is already in some ways feasible. Particularly in internal B2B scenarios in places where the installed base of legal infrastructure is low, or in legal jurisdictions that have inherently less complexity, the opportunity exists to test and refine smart contracts. In scenarios such as these, smart contracts may not take as long to become viable. Major financial institutions have been eager, rather than reluctant, to experiment with blockchain-based transactions, and certainly the tech sector’s interest and involvement is high. In the public arena, bold blockchain-based peer-to-peer marketplace experiments such as OpenBazaar are already poised for launch.
Codification of legal agreements using proprietary and open methods seems feasible today. For straightforward, simpler processes, the technology exists. But bugs will certainly need to be worked out, processes will often be difficult to transform, and IT infrastructure itself will need to evolve.
More complex smart contracts and distributed autonomous functions, business units, and organizations imply a much bigger challenge.
But over the long term, the greatest promise is with intricate forms of agent-managed peer-to-peer automation—a highly efficient Internet of Things empowered by an Internet and web of agents, smart transactions, and contracts. The rest of the 2010s likely will be a period of tinkering, comparable in some ways to the late 1990s. Considering there are hundreds of both blockchain and artificial intelligence startups, and sizeable venture capital (VC) investments across both, the possibility also looms of a boom-and-bust period that could mirror the dot-com era in its breadth and depth. By the time the last half of the 2020s materializes, companies might have made their way through what Gartner calls a Trough of Disillusionment to the adoption of a transactional environment very different from today’s.