Blockchains and the introduction of smart contracts - Do you still need a lawyer?
By Anna Guise
At the time of writing, Bitcoin reached a value of over $11,000 USD for a single coin. With such a substantial (albeit extremely volatile) value, Bitcoin has become a hot topic in recent months. With an average of 150,000 Bitcoin transactions occurring each day and over 1,000 different types of virtual currency available for purchase online, it appears that the way in which we trade and invest our money is undergoing a significant change.
Behind the phenomenon and hype of virtual cryptocurrencies is blockchain technology. While receiving fewer headlines than Bitcoin, blockchain technology is the foundation that these virtual currencies are built on. Blockchain technology, while still in its infancy for use in commercial transactions in New Zealand, has the capability to change the way we do business, particularly with the development of smart contracts.
What is a blockchain?
A blockchain is a digital form of technology used to record transactions between a network of people and organisations on a ledger that is replicated and distributed across many parties. In the case of Bitcoin, blockchain technology is the underlying system used by Bitcoin to record the transfer of the currency between users on the network. Since the introduction of Ethereum (a decentralised platform for blockchains) blockchains can record not just financial transactions, but any form of computation, including smart contracts. The technology is called a blockchain as each transaction or bundle of transactions adds another ‘block’ to the existing chain of transactions on the network. In the case of the Bitcoin blockchain, each block can contain up to 2,000 transactions.
What are some common characteristics of a blockchain?
While each blockchain has its own architecture, the common characteristics of a blockchain include that they are:
Blockchains can also be permissionless or permissioned. A permissionless blockchain allows anyone to access and participate in the network, while a permissioned blockchain only allows certain organisations or individuals onto the network.
- Distributed: The transactions recorded on a blockchain are shared across multiple ‘nodes’ on a network. This means the ‘nodes’, or individuals who verify blockchain transactions, each hold their own copy of the entire transaction history and can each see what is happening on the blockchain in real time. There is no ‘master copy’ of the transactions and no central server to hold all information.
- Decentralised: Unlike most everyday transactions where a trusted third party or central authority oversees the transaction, a blockchain has no central authority. Instead, a blockchain is run and maintained by the ‘nodes’ on the network. This means that blockchain transactions are recorded by consensus and must be verified by all ‘nodes’ on the network. Once a consensus is reached through a cryptographic method called a ‘consensus mechanism’, the transactions will be validated.
- Immutable: The transactions on a blockchain cannot be edited, deleted or altered. As every ‘node’ holds a record of all transactions, any attempts to alter the existing blocks in the chain will be rejected by the other users. This also means that transactions cannot be reversed.
- Anonymous: Blockchains are also often designed so that the users on a network remain anonymous. Instead of a name for a user on the network, you may find a long random sequence of numbers and letters in its place.
How is blockchain technology used? Blockchain technology, beyond virtual currency, has the potential to be used within a wide range of industries. In our opinion, one of the most relevant uses of blockchain technology in commercial business transactions is the development of smart contracts. Smart contracts are programs of code that define a set of rules and can self-execute these rules without the need for human involvement. Blockchains are used to store these smart contracts, execute the instructions they contain and provide a record of the automated contractual performances that have been completed by the program.
This means that certain contractual obligations in the future may become fully automated which may reduce transaction costs, streamline the contracting process, and remove the need for ‘middle men’ in some parts of the transaction. For example, if a blockchain-based land register were to be created in New Zealand, the Sale and Purchase Agreement could take the form of a smart contract, so that when payment is made, the land title is automatically transferred to the purchaser, potentially removing the need for lawyers and trust accounts in this stage of the transaction.
Currently, the use of smart contracts in complex transactions is still in its early stages. While there are varying reasons for this, one obstacle is that it is currently difficult to feed verified information or events, occurring in the non-digital world (known as ‘oracles’) into a blockchain. For example, if a smart contract were designed to automatically execute a payment for goods upon delivery, how would the blockchain know with certainty when the goods had been delivered? And who has the authority to make such a declaration on the blockchain?
There is also the potential for blockchains to be incorporated into a wide range of other areas including securities trading, insurance contracts, cross-border remittances, and data storage.
Blockchains – moving forward.
As the uptake of blockchain technology in New Zealand business is still in its infancy, how blockchain technology may be incorporated into business transactions and other industries is still largely speculative.
However, the use of virtual currencies and the integration of smart contracts into business transactions has the potential to streamline, automate and simplify commercial transactions and change the way parties contract with each other – while you still currently need the ‘middle men’ in your day-to-day commercial transactions, this will be an interesting area of technological development to watch.
The New Zealand Financial Markets Authority has also released guidelines on cryptocurrencies, and how these products tie in with the regulation of securities in New Zealand. These guidelines and further commentary can be accessed by clicking here.
For more information about anything discussed in this article, please feel free to contact Anna Guise.