Smart Contracts Are Not What You Think

It is 2035. The US dollar is not a reserve currency anymore because nobody buys oil or borrows from the IMF or World Bank. IRS, once the biggest US-dollar creditor in the world, is struggling to tax decentralized cryptographically protected businesses freely operating across borders. A lot fewer economic players need US dollars because their debts (taxes, loans, and invoices) are not denominated in US dollars.

What does this have to do with smart contracts and lawyers you ask?

If technology, new energy sources, and rising third-world wealth cause these cataclysmic changes in the financial system, cryptoeconomies (aka blockchains) will fill in the gaps and meet new needs in a future world with no single-currency bias and little trust in central banks. One of the top and most common financial innovations in cryptoeconomies will be automated payments between machines or between machines and humans. Software that controls these payments is known as smart contracts today.

Automated payments are possible in conventional economies that are based on central banks, even today and even between machines. Parties must hold fiat currencies such as US or Canadian dollars to participate. The biggest downside of fiat currencies is that they require holders to surrender them to banks to make payments (apart from payments by banknotes, the transaction cost of which is directly proportionate to the transaction size). Central banks stringently screen banks and governments heavily regulate them. Banks will immediately comply with court-issued enforcement processes or government seizure orders in proper form. They can also deny access to the payment system without recourse at will because of their nominally private status. Also, since central banks issue fiat currency at discretionary emission rates, they have the power to transfer wealth from creditors to debtors. Biggest debtors are sometimes governments running budget deficits (with creditors being fixed-income citizens paying more for everything). Finally, conventional payment clearance times are painfully long by machine standards. Although various abstractions such as credit cards can speed things up, they are by nature tenuous as banks are known to block cards arbitrarily due to their extreme risk intolerance. It also takes days for card payments to settle into actual money—a process which a simple dispute can delay or stop.

From a purely physical point of view and without any moral judgment, fiat money is reversible thanks to the centralized nature of the banking system. It is reversible by governments, plaintiffs, banks, credit card processors, central banks, and so on.

Crypto money is irreversible by design. This is a huge advantage to parties concerned with regulatory or political risk. Another advantage is instant or near instant settlement/clearance time compared to fiat. You can’t beat that if the world economy consists mostly of machines and international decentralized businesses, and the US dollar is not important anymore. The pull of cryptoeconomies will be too strong to resist.

So “smart contracts” will proliferate. But lawyers will not write them because “smart contracts” are not contracts.

Lawyers will not write smart contracts just like lawyers do not write any other software code that affects legal rights and obligations today. Do lawyers write automated stock-trading software, code that ships product when a condition is triggered, even software that adjudicates Ebay disputes? All of these are perfect analogies of smart contracts with respect to the role of lawyers. No lawyer writes code as practice of law because it’s not. Lawyers may guide business analysts that design specifications for software engineers but they do not and will not write code. Let each do their own.

Two words are responsible for the confusion around the notion of lawyers writing smart contracts: “write” and “contract.” Lawyers writing contracts is the essential form of law practice and someone must write smart contracts so it looks like lawyers would do it (or others—dramatically taking work from lawyers).

The word contract has two meanings: a set of agreed rights and obligations (based on offer, acceptance, consideration) and written evidence of such rights and obligations. Of course, most of the time, a written form is not a necessary property of contracts (a fact responsible for much litigation).

Smart contracts are not written evidence of agreed rights and obligations because (1) they encapsulate only a portion of any rights and obligations that is related to contractual performance; and (2) they may exist without any agreed rights and obligations at all.

On the first point: smart contracts are computer directives telling a decentralized computer managing cryptographically protected assets to do something with the assets when certain conditions are fulfilled. If these conditions and actions they trigger arise out of a legal contract, then the smart contract is merely a program executing some aspect of a contract.

On the second point: a smart contract can distribute gifts (not a contract); it can pay taxes (not a contract); it can pay fines (not a contract); it can pay automatic compensation for a wrong (not a contract). Finally a philosophical question: if a cryptoeconomy is outside the reach of any court, can a contract even exist?

Smart contracts is a great term for designers and participants of cryptoeconomies. They get it. The Ethereum community is not confused by smart contracts. As for lawyers, my advice is: don’t worry about smart contracts for now. Engineers will come to you later when cryptoeconomies become too big for traditional economies to ignore.