Blockchain technologies are rewriting the rules of the legal system – Kate Sills explains how
Are smart contracts smart enough to solve our legal problems?
Kate Sills, a software engineer and former board member of the Tezos Commons Foundation, spends a lot of time thinking about how blockchain technologies like smart contracts and NFTs can improve legal systems. In a Plumia Talks live interview, Sills shared her views on the potential of smart contracts and how they’re shaping the future of the law.
Smart contracts 101
A smart contract lays out the terms of an agreement, these are then executed by code that runs on a blockchain. “A smart contract is not a legal contract but it can serve some of the same purposes,” Sills says. She adds that in order to understand smart contracts, it’s necessary to first understand traditional legal contracts.
The key thing that makes a contract “legal” is enforcement by the state. Considered the basis of modern trade, legal contracts solve for what economist Thomas Hobbes called “transactional insecurity.” When someone enters a trade with another party, they are vulnerable to that other party not fulfilling their end of the bargain.
With state-enforced legal contracts trading parties don’t have to rely on the promise of others. Instead, both have remediation pathways if the other party doesn’t follow the terms of the deal. Legal contracts are costly to enforce, but once a decision is rendered it is binding and enforceable by the state.
By contrast, the state has no role in a smart contract or its enforcement. Instead of relying on a neutral third party, smart contracts automatically trigger through code. In a trade example, both parties send their items into the smart contract, which technically takes possession of the (digital) goods. When the contract’s terms are fulfilled, the smart contract executes on the agreement and gives all parties what they are owed.
“One thing that is really different about smart contracts versus legal contracts is that a smart contract is code on a blockchain that, in order to enforce any kind of transfer, has to take possession of the virtual objects,” Sills says.
Smart contracts are especially suited to digital transactions. For example, an ecommerce transaction for a digital good.
Transactions with binary rules. Code is very good at adjudicating binary decisions based on digital inputs. For instance, if someone deposits funds, they get the benefit. If they don’t deposit funds, they don’t get the benefit.
When transparency is critical. Smart contracts are typically transparent, making it easier to see flows of information, digital goods, and money. Sills said this could be particularly helpful in government, where transparency is required but often lacking.
Setting up individual incentives. When multiple people require different incentives within an agreement, smart contracts can execute all of them simultaneously (provided they are digital in nature or can be encoded, such as financial transactions).
The future of smart contracts
When a contract requires physical-world enforcement, smart contracts do fall short. While a smart contract could transfer ownership of a property, for instance, it has no mechanism for enforcing that the buyer also hand over the keys to the property.
Similarly, smart contracts can’t identify whether physical-world events happened. Smart contracts use action-based triggers (such as someone depositing funds), but it’s difficult to digitally verify if something happened in the physical world, such as handing over house keys after a real estate transaction. A workaround is to use blockchain oracles – a system where trusted individuals input actions into the smart contract to fulfill its terms – but this opens up opportunities for bad actors.
Smart contracts cannot enact punishment after the fact. Unless someone has already put something into a smart contract – for instance a deposit they lose if they don’t fulfill the terms – the wronged party will have to rely on the traditional justice system.
While smart contracts have a lot of potential, Sills said it’s important to not believe all the hype just yet. “We have to be really careful about what we're promising and what we're not,” she says.
“A decentralized system in a decentralized form, even in a very limited scope, enables a lot of possibilities,” Sills says. “It takes one of these primary responsibilities of the government system and it makes it possible to do so just with technology.”
She said instead people need to realize both that smart contracts are not replacements for legal contracts and they also have inherent issues such as limited enforcement capabilities or incentive problems when using blockchain oracles.
That said, the potential shouldn’t be overlooked either, particularly for those looking to build a new kind of justice system rather than marginally improve the current process. “We have to realise that law is only as legitimate as people think it is,” Sills says.
