This spring, Arizona became one of the first states in the U.S. to enact a law explicitly granting smart contracts the same legal effect, validity and enforceability as their standard contract counterparts. “Smart contracts” are automatically executing agreements that run on the blockchain technology platform. Blockchain was first deployed to allow for transactions involving the Bitcoin cryptocurrency, and it was later enhanced by the Ethereum blockchain platform, which was specifically designed for smart contract applications.
Current legal state of smart contracts and blockchain technology
Taking the lead last year, Delaware started the Delaware Blockchain Initiative (DBI), which is probably the most well-known state program focused on smart contracts and blockchain technology. Delaware’s then-Governor, Jack Markell, launched DBI to jumpstart recognition of blockchain technology under state corporate law, an especially significant move considering the many companies incorporated in that state.
Also last year, Vermont passed a bill making it possible for blockchain-registered digital records to be admissible in court.
More recently, Arizona introduced the so-called “Smart Contract Bill” in early February, and it quickly landed on the Governor’s desk for signature on March 29. Arizona’s new statute does more than recognize the legality of smart contracts—it also brings any signature, record or contract that is “secured through blockchain technology” within the ambit of the state’s Electronic Transactions Act. Other jurisdictions could recognize smart contracts under existing state laws modeled on the Uniform Electronic Transaction Act or the federal Electronic Signatures in Global and National Commerce Act, without having to pass smart contract- or blockchain technology-specific legislation.
In an interesting twist, since passing the bill, Arizona has switched gears and is now identifying discrete areas where blockchain technology should not be used. Just last month, for instance, the state passed a new law prohibiting the use of blockchain technology to locate or control firearms.
The latest version of Nevada’s blockchain bill passed unanimously in the state’s Senate a few weeks ago and is pending review by the Assembly. Similar to the Arizona measure, Nevada’s bill allows blockchain technology and smart contracts to qualify as viable electronic transactions under the state’s Uniform Electronic Transactions Act. It also goes further and forbids local governments from charging money or requiring licenses for using blockchain technology or smart contracts.
Other states are also addressing smart contracts and blockchain technology in 2017. And bills or resolutions involving blockchain technology are making their way through the Nevada, Hawaii, New Hampshire, and Illinois legislatures.
Refresher on smart contracts
The concept of automatically executing “smart contracts” has been around for quite some time. A vending machine can serve as a basic illustration of the concept: a particular event—here, the insertion of a $1 bill—triggers an automatic outcome—the dispensing of a soda. Automating the offer, acceptance and execution of the contract underlying this transaction has improved cost and efficiency and has eliminated the need for a middleman.
When used in blockchain technology, smart contracts are code that use similar “if-then” logic that executes a particular agreed-upon contract automatically. For example, driving away in a rented car could be effectuated by the successful execution of a smart contract via code installed in the car. The smart contract would automatically allow the car to start when the renter has successfully made payment and signed rental documentation.
These two smart contract examples can work without using blockchain technology, but the technology provides substantial additional benefits. At its most basic, a blockchain is a shared and distributed ledger, whereby a continuously growing chain of transactions is stored across multiple computers and networks. Each transaction, or “block,” is first verified by the authorized users of the network, then added to the chain to become part of the next “block” of information, providing an immutable, transparent and encrypted history of transactions that is much more difficult to hack, compared to most other kinds of transactions that occur electronically today.
As a result, when combined with blockchain technology, smart contracts are automatically executing, transparent, trustworthy and decentralized. As each party to the transaction relies on the identical blockchain ledger (and not on their own, potentially inconsistent centralized databases), blockchains and smart contracts working together become powerful tools for redesigning routine and ministerial tasks into highly efficient, cost effective and trustworthy processes. The advantages over manual, paper-based agreements using intermediaries for enforcement are considerable and transformative.
Upcoming smart contract and blockchain technology projects
Many businesses, governments and other groups are already identifying areas where smart contracts and blockchain technology could improve efficiencies, increase trust and reduce costs. For instance, in Brooklyn, N.Y., several neighborhoods are participating in the Brooklyn Microgrid, a project that uses smart contracts to automatically buy and sell energy produced by solar panels installed on local roofs. These contracts run automatic auctions to sell small amounts of electricity to users who will pay the most for energy at a particular time. The technology permits 24/7 automatically recorded and trustworthy trading with no intermediary.
In California, the Share&Charge platform will connect electric vehicle owners to public and private charging stations. Smart contracts will automatically charge users of the stations and allow station owners to set lower prices for friends and family. Share&Charge was originally developed and used successfully in Germany. Ultimately, the company hopes to expand the technology to easily share or rent energy, parking spots and electric vehicles themselves.
Recently, nineteen multi-national banks (including Credit Suisse, Barclays, Danske Bank, U.S. Bank and Wells Fargo) participated in a proof-of-concept demonstration of a new blockchain-based syndicated loan servicing program, called Synaps Loans. The program will work by including every party to a particular loan trade on shared smart contracts that interact automatically and permit users, for example, to verify ownership of a loan without having to formally ask an agent at a bank. The demonstration showed how trades that usually take over a week can be settled in less time using the program, with the added bonus of lower costs and higher transparency.
In the world of advertising, Nasdaq announced a plan to launch the New York Interactive Advertising Exchange, or NYIAX, later this year. NYIAX will allow advertisers and publishers to buy, trade and re-trade guaranteed digital advertising contracts months in advance. Once a trade occurs, smart contracts will execute certain obligations automatically: for instance, a seller will deliver digital ad impressions and a buyer will immediately pay for media upon ad delivery. By the end of the year, NYIAX also intends to move into TV, print and radio ad contracts.
And Delaware, through its DBI, is uniquely positioned to transform corporate law by increasing the use of smart contracts and blockchain technology. DBI is beta testing a blockchain technology application for storing, distributing and encrypting documents in its public archives. One of its latest projects involves the development of “smart UCC-1” filings. This project will automate the paper-heavy, manual and time-consuming process lenders must follow when a party has made a loan that uses property as collateral. Smart contracts will automate UCC filing renewals, reduce mistakes and fraud, expedite record searches and cut costs.
The future of smart contracts
Smart contracts are making serious headway in 2017 as a variety of governments and industry players develop ways to use them to improve historically slow, centralized and opaque processes prone to error, hacking and fraud. Lawyers, regulators and other market participants will need to understand how smart contracts work as the technology becomes more and more popular. The open question is no longer whether they will become ubiquitous but whether and when they can be programmed to execute ever more complex tasks on blockchain platforms. The implications of that development for both global government and business would be revolutionary.